I buy stocks mostly based on low PE ratio. Are there situations where a stock is a bad buy in spite of having a low PE? What's the next major stat I should look for before concluding?


Yes, there are situations where a stock is a bad buy in spite of a low PE.

PE ratio tells you the current share price divided by the prior 4 quarters earnings per share. It does not consider:

  • assets
  • liabilities
  • sustainability of the business
  • competitive threats
  • management competence
  • management integrity
  • cash flow
  • dozens of other things crucial to an investment decision

Imagine someone walked up to you and said, "Do you want to buy a piece of my business? I'll sell you 1% of it for $1000. Last year the business earned $25000." A quick calculation shows a PE of 4 [$1000/($25000 *.01)]. Even though this PE is comparatively low, you wouldn't buy in without a lot more info.

What kinds of things might you ask?

  • What kind business is it?
  • Who are your competitors?
  • Who is leading the business?
  • Can I trust the leaders?
  • What assets does it have?
  • What liabilities does it owe?
  • What will the business look like in 10 years? 20?

PE is one tiny component of an informed investment decision.

  • Nice. Fairly comprehensive while also being easy to read. – George Marian Nov 1 '11 at 2:59

PE can be misleading when theres a good risk the company simply goes out of business in a few years. For this reason some people use PEG, which incorporates growth into the equation.


Some companies have a steady, reliable, stream of earnings. In that case, a low P/E ratio is likely to indicate a good stock.

Other companies have a "feast or famine" pattern, great earnings one year, no earnings or losses the following year. In that case, it is misleading to use a P/E ratio for a good year, when earnings are high and the ratio is low. Instead, you have to figure out what the company's AVERAGE earnings may be for some years, and assign a P/E ratio to that.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.