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updated on 29 July 2017
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Many small and midcap stocks have more than doubled investors’ wealth in the last one year without much improvement in the earnings, which is depicted by low earnings per share and high PE multiple.

The Indian market has produced many multibaggers in the last one year and one such theme which catches attention are stocks which are trading at three-digit PE and low earnings per share (EPS).

Before we go further, let us understand the relation between the PE, EPS and market price. Price earning multiple or earnings multiple is calculated by dividing market price by earnings per share (EPS).

Many small and midcap stocks have more than doubled investors’ wealth in the last one year without much improvement in the earnings, which is depicted by low earnings per share and high PE multiple.
In other words, if earnings fail to catch up in near future then companies with high PE multiple and low earnings per share could come under pressure.

Companies, which are trading with three digit PE multiples include names like Medicamen Biotec which rose 444 percent, followed by Generic Engineer which rallied 271 percent and International Combustion rose 205 percent in the last one year. The following table shows the list of other such stocks.
High PE may not be the only reason why a stock could witness correction. But, to safeguard from any adverse volatility, investors should first study the reason of high PE and if required try and avoid exposure to small and midcap stocks which have high PE and low EPS.

It is prudent for investors to understand that taking investment decisions just based one parameter i.e. PE multiple might not be the right strategy.

Investors also take into account the book value, sales, replacement value of assets, brands into consideration. Hence, while on the face of it, a PE valuation of 100x is not sustainable, it is possible that investors are valuing the company on other parameters, suggest experts.