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De-rated, but rising

Companies that have witnessed a de-rating in their P/Es while giving high returns over the last one year

De-rated, but rising

The price-to-earnings ratio (P/E) is one of the most widely used valuation multiples. It tells us how much investors are willing to pay for every rupee earned by a company. For example, Infosys trades at a P/E ratio of 30. This means that for every rupee earned, the investors are willing to pay Rs 30 to Infosys. A stock may command a high P/E ratio due to multiple factors, such as future growth prospects of the company, good management, anticipation of higher earnings due to expansion, a dominant market share, etc.

Like many other things, the P/E ratio of a stock also changes with time. There are several factors which may lead to a P/E re-rating or even a de-rating. A re-rating occurs when the P/E ratio of a stock increases or expands, which implies that investors have gained even more confidence in the company and are thus ready to pay a higher price per rupee earned. About a year back, Infosys' stock had a P/E ratio of 20 times. However, now its stock trades at a P/E ratio of 30. This could be attributed to an increase in the demand of IT services due to the disruption caused by this pandemic. P/E expansion is highly desirable for investors as it results in even more gains than just price appreciation at a constant P/E.

In contrast, de-rating happens when the P/E of a stock contracts. This can lower the gains as investors are not willing to pay the same amount of money for one rupee of earnings of the company. A de-rating can happen due to uncertainty regarding the company's future, a possible disruption, poor track record of the management, etc.

The companies compiled below have witnessed a de-rating in their P/E ratios in the last one year but have still been able to deliver good returns. This could be attributed to a significant increase in their earnings. Do note that we have removed the effect of any exceptional items or tax write-backs from their profits.

So, if these stocks attain their older P/Es, that could result in potential gains for investors. For that to happen, these companies must maintain the momentum in their earnings growth. Keep an eye on them.