But like High PE, here too, there is another possibility - it can also mean that the market expects the company to grow at a slower rate, or not grow at all. This is also true when the PE ratio of an entire sector is very low - it may mean that the sector in general would not grow as well as the other sectors. (For example, the current PE ratio of the Information Technology - IT - sector is lower than the PE ratio of many other sectors, because IT companies are not expected to grow as fast as companies in other sectors like Power, for instance).

I won't repeat the example for Low PE, but the principle remains the same.

When the market expects a company to grow at a slower rate compared to its peers, or show a negative growth, it will give a lower PE ratio (or a lower market price for the stock) because the slow / negative growth in earnings (and in turn the slow / negative growth in the Earning Per Share or EPS) would ultimately bring the company's PE to the sector average levels.

In conclusion, a low PE means either:

- The stock of the company is cheap, or
- People expect the company to grow slower than its peers, or show a negative growth

Rule 3: PE isn't helpful in case of loss making companies

PE ratio might be totally irrelevant in case of companies just starting out, as they might not be making any profits. Same is the case for other loss making companies.

Since there is no or negative EPS, the PE ratio would also be negative, and would not convey much.

Rules of thumb

These are the general principles based on the PE ratios of companies currently being traded in the market.

Generally, companies in mature industries or markets have a stable and moderate growth rate. Such companies usually have a low to moderate PE ratio.

Companies in high-growth industries or markets show rapid growth. These companies usually have a moderate to high PE ratio.

Now that you know how to interpret the PE ratio, go ahead and try to find out why some companies are traded at a higher PE than others!!

Other articles you might be interested in:

• What is Price to Earnings (PE) ratio?
• Stocks - The winning bet for the long term
• What is Compound Annual Growth Rate (CAGR)?
• One size doesn't fit all
• Have you "invested" in jewellery?
• ELSS is not for someone else
• Are ULIPs a costly form of term insurance plus MF investments?
• Shine matters - Gold is not old
• Goal Based Investing
• Direct investment in Stocks versus Mutual Funds (MFs)?