How important are the P/B ratio and P/E ratio while selecting a mutual fund? Should they dominate the decision?
- Ankit Mundra
Well, the P/E ratio and the P/B ratio are essentially valuation measures and they tell you about the kind of premium that the markets are willing to pay to every rupee of a company's earnings. So, typically, the stocks which the markets expect to grow at high rates from hereon tend to command a premium and therefore, they tend to have higher P/E ratios.
Now in the case of a mutual fund, a P/E ratio is simply the weighted average P/E ratio of all the stocks that it holds in its portfolio. Typically, funds that follow a growth style of investing would tend to have a higher P/E ratio, while the ones that are value-oriented or follow a contrarian style of investing would tend to have more moderate P/E and P/B ratios.
Now with regard to your question, well I'll suggest that right at the beginning, the focus should be on identifying funds and fund managers that have a track record of doing consistently well through multiple market cycles. So, one should look for funds that have done consistently well through the ups and downs of the market and avoided big disasters. Once one has been able to zero in on a narrow list of such funds, then one may refer to these valuation ratios of a fund like a P/E ratio to bring some style diversity in his selection of funds which he wants to eventually add to his portfolio.
That is because if you look at long periods, you would see that funds that follow different investing styles would still have done well consistently over a period of time. So, it may not hurt to bring some style diversity - some growth as well as some value flavour - in your portfolio and for that, one may refer to the P/E ratio as the last check.