June 10, 2011 | In: Opinion

Very Low P/E: A Sign of Mistrust?

After my recent post on the top 100 stocks with low P/E, I started wondering, if these stocks have such a low P/E, it means that they do not attract investors. But why is that?

I looked at two very known examples of stocks with low P/E: AIG and RIMM. These stocks have a P/E of 2.64 and 5.80, respectively. Both are huge companies, but they seem to be unattractive to investors. Let’s look at each company individually.

AIG: American Insurance Group was considered too big to fail by the US government, but it did fail, from an investor’s perspective, when its stock fell below the $10 level in 2009 after trading at the $1,400 level a year earlier (both prices are after taking the reverse split of 1:20 that happened on July 1st of 2009 into consideration). Many investors flew the stock, after being burned badly from its collapse, and never returned. Very few investors saw value at the $10 level and started buying the stock at this point, while others started following the herd and the (positive) rumors, and started buying the stock when it went up again to the $50 level. The stock now dropped to below $30 (it is currently trading at $27.90). Most traders now refuse to be fooled again by this horrible stock, and are staying clear from it, until sustainable growth in the US economy is evident.

RIMM: Research In Motion is a Canadian company that is refusing to adapt to the current market conditions and demands. They are producing horrible devices, ignoring their cash cow, and if they persist on doing so, they will go bankrupt. RIM is a perfect example on how investors treat a company not based on its current earnings, but based on its future earnings, and most investors do not see any future for RIM if they (RIM) do not address the flaws in their business strategies.

As you can see from the above, investors do not trust neither AIG nor RIMM, and that’s why both stocks are trading at this very low P/E. Although both companies are making a lot of money now, investors are wary of these companies’ future, and they want to see a complete change in direction before trusting these companies again.

Now there are other reasons why investors mistrust stocks (resulting in them having a low P/E), these reasons include:

  • Scam rumors: Rumors that the company is lying about its balance sheet.
  • Company probed: The company is for example probed by the SEC.
  • Risky market: The company operates its main business in a very risk market.

Now a question that many investors ask, what is a healthy P/E ratio? We now know that a P/E that is too high means that the company is overvalued and a P/E that is too low means that investors do not trust the company for one reason or the other.

I believe that a P/E between 10 and 25 (±10%) is considered to be healthy. If you take a look at most well funded companies with strong balance sheets and a reputable history, you’ll find that their P/E is within that range. Take a look at GOOG, AAPL, and MSFT.

1 Response to Very Low P/E: A Sign of Mistrust?


What Is a Good P/E Ratio? « Fadi El-Eter

July 27th, 2011 at 7:28 am

[…] have discussed before the dangers of a low P/E ratio; in short, a very low P/E means that the investors do not trust the company and its stock. This is […]

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