Generally, investors are in search of stocks with a low price-to-earnings (P/E) ratio. The idea is that the lower the P/E, the higher will be the value of the stock. It means a stock’s current market price is not priced in yet, and has room left to run owing to its higher earnings potential. This clearly justifies investors’ inclination toward low P/E stocks.
But stocks with a rising P/E are also worth a bet. We’ll tell you why.
Why Rising P/E a Valuable Tool?
Investors should note that stock price moves in tandem with earnings performance. If earnings come in stronger, the price of a stock shoots up. Solid quarterly earnings and the forward guidance boost earnings forecasts, leading to stronger demand for the stock and a rise in price.
So, if the price is rising steadily, it means that investors are assured of the stock’s fundamental strength and expect some strong positives out of it. Suppose an investor wants to buy a stock with a P/E ratio of 30, it means that he is willing to shell out $30 for only $1 worth of earnings. This is because the investor expects earnings of the company to rise at a faster pace in the future on the back of strong fundamentals.
Also, studies have revealed that stocks have seen their P/E ratios jump more than 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.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth
Percentage change in last year EPS should be greater than or equal to the previous year
(These two criteria point to a positive or flat earnings growth trend over the years).
Percentage change in price over four weeks greater than percentage change in price over 12 weeks
Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks
(These two criteria show that price of the stock is increasing consistently over the said timeframes).
Percentage price change for four weeks relative to the S&P 500 greater than percentage price change for 12 weeks relative to the S&P 500
Percentage price change for 12 weeks relative to the S&P 500 greater than percentage price change for 24 weeks relative to the S&P 500</…….