One of the most common forms of investing techniques is running after stocks with a low price-to-earnings (P/E) ratio. That’s because this basic measure of how much investors are spending for $1 worth of earnings speaks of undervaluation. The logic is simple — a stock’s current market price does not justify its higher earnings and therefore leaves room for upside.
But have you ever given it a thought that stocks with a rising P/E can also be worth buying. We’ll tell you why.
How Does Increasing P/E Theory Work?
The concept is that as earnings rise, the price of the stock goes upward. As forecasts for expected earnings come in higher, strong demand for the stock should continue to push up its prices.
A stock’s P/E gives an indication of how much investors are ready to shell out per dollar of earnings. So, if the P/E of a stock is rising steadily, it means that investors are assured of its inherent strength and believe that more positives are to come out of it.
Also, studies have revealed that stocks have seen their P/E ratios jump over 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.