LONG TERM INVESTMENT: CRITICALLY EVALUATING THE SPECULATIVE NATURE OF INVESTING IN HIGH PE RATIO STOCKS

Abstract

Price to Earnings ratio is one of the most significant and top used financial metric when it comes to fundamental analysis and investment decision making. Even the market moves based on the expected PE ratio and adjusts itself from time to time accordingly. This study aims at critical evaluation by comparing a stock purchase at a historic date at a higher PE multiple with a current date and calculating returns on both stock price levels as well as dividend yield level over the entire period in absolute terms. It wants to highlight that a purchase at higher PE falls out of the definition of investing and should be categorized and treated as speculative for very clear reasons that are critically evaluated in this study. It is noticed that unless the company grows top line and bottom-line exponentially, a stock purchase at higher PE delivers very dismal dividend yield if any and mostly negative return on account of stock price depreciation rather than appreciation. Hence, such purchase can be said to be speculative as it relies solely on momentum stock price rise for gains.