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A trick that works best to make money from investing in stocks

PE Multiple
It’s really hard for a newbie to decide which particular stock to invest in to generate profits. One trick that really worked for me over the years is the PE multiple. So what is PE multiple? PE stands for the price to earnings ratio. This ratio lets you decide whether the stock you are investing in is undervalued or overvalued. The lower PE value indicates the stock is undervalued while the higher PE value shows the stock is overvalued. I have noticed the price of undervalued stocks appreciate fast once such stocks get the attention of the investors or short-term traders.

The most important thing for any investor is to recognize such undervalued stocks and buy them before anyone else does and that is how it is going to make him/her good money. You may be wondering what exactly an undervalued stock is? We can better understand this with an example. As you know every stock listed company announces it’s quarterly results and by looking at the company’s balance sheet you can easily know how much profit or loss was generated by the company during a particular quarter (3 months period). Now if you can add the profit of all the 4 quarters, it will give the profit of the company for the whole year.

By simply dividing the total profit (for the full year) with the total number of shares in the company, you can obtain earning per share (EPS). Suppose the company made a profit of 4 crores (4,00,00000) for the full year and a total number of shares issued by the company during the public offering was 50,000,00. So the yearly EPS will be 8 (4,000,0000/50,000,00). Again, let us assume that at any particular point of time the stock of the company was trading at Rs.48 which is 6 times of its yearly EPS of 8 (6*8=48). This is what PE (price to earnings) is as mentioned in the first paragraph above. To clarify again PE is 6 which means the company’s stock is trading only 6 times of its yearly EPS of 8.

PE below 10 is considered very low and stocks trading at such low PE are considered as undervalued stocks. This is because the price of such stocks have not appreciated in accordance with the profit generated by the company. The general rule of thumb is the price of the stock should appreciate as the company grows in terms of sales and profits and PE multiple will tell you when this is not happening. But the problem is PE multiples can shrink to a great extent during a bear market and it may expand during times when the bull market is operational.

But this is not all. Some industries in general trade at low PE and in that case it will be difficult to know whether the stock you want to buy is undervalued or not. This is where comes the role of industry PE. What you can do is to compare the PE of the stock you want to buy with the industry PE, and that will exactly let you know if the stock you want to buy is undervalued or not. So what is industry PE? Industry PE is actually the average PE of all the companies operating in a similar industry.

You may be wondering how to get all these data of PE and industry PE so that you can decide what to buy so that it is undervalued. All these company data are actually easily accessible on sites like moneyworks4me.com. Suppose you want to know if coral laboratories (a pharma company in India) is undervalued or not. Just go to moneyworks4me.com and type this company name in the search box above or simply click this coral laboratories link which will directly land you on the data sheet of this company. In the middle of the page, you can easily find the PE company is trading at and industry PE under “Latest Financials”. If PE is too less as compared to the industry PE then it’s a green signal for buying the stock.

You may also be wondering if it is hard to find undervalued stocks. It’s actually easy to find. What you can do is to simply register with screener.in and get a username and password. Then you need to login to the site using that username and the password. Once you are logged in, there will appear a big search box in a square shape (under create a custom stock screen) near the bottom of the home page. Just use this query >> "PE < 10 " or something similar in the box as per your needs and click "Run this screen". This will give a huge list of stocks which are trading at PE less than 10 and thus undervalued.

Best time to find such undervalued stocks is after the quarterly results of the companies are announced at bseindia.com. At that time more than 5000 stock listed companies come up with the quarterly results simultaneously and so many of these companies get unnoticed for their better results and so these companies stocks remain undervalued for quite some time. But sometimes later the price of such stocks rise significantly when the investors realize the true potential of these stocks.

Disclosure: The information presented here is through my personal experience and opinion and future results are not guaranteed as a lot will also depend on the debt to equity ratio and cash flow of the company.

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Written by: Rajesh Bihani who is the webmaster of this website. Know more about Rajesh Bihani).

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