Here we explain how P/E can fall despite an increase in price. Also, we give a list of stocks that witnessed this.
Recently while looking at a company, there was something rather peculiar. The company had very good returns in the last five years, but its price-to-earnings ratio (P/E) had fallen during the same period. This was clearly something new. (It wasn't actually, but it makes a good intro).
Returns and P/E
Whenever a stock has given great returns, most probably, its P/E also grows. Take the example of Berger Paints. Its five-year return is 21 per cent and its P/E went up from 54.2 to 71.9. This is quite normal, and this is how it should be, right? No, not necessarily.
How price and earnings affect P/E
Price to earnings (P/E) has two components, as the name says - the first is price and the second is earnings or earnings per share (EPS). The P/E of a company will increase either if the price goes up (more than EPS) or if EPS falls (compared to price). Similarly, the P/E of a company can fall if the price goes down (more than EPS) or if EPS increases (compared to price). So essentially, if growth in EPS is more than growth in price, then despite giving high returns, the P/E of a company would fall. All clear?
We have assembled 15 companies whose P/E has fallen (despite giving high returns) compared to what it was five years ago. Of course, we can't give you random companies because in this market, prices go up for no reason and companies post sudden growth in profits too. So we applied certain filters:
We obviously eliminated companies whose P/E dropped due to exceptional items or those that have become profitable only for the last couple of years. Here are 15 examples where EPS grew more than price resulting in a fall in P/E:
Suggested read: The curious case of Info Edge's P/E