Investors buy stocks with high P/E (Price/Earnings) ratios because these offer shares in growth companies, and earnings within the company are expected to continue to grow (increase). This continued growth has the potential to correspondingly continue to increase the value of the stock price in the market exchange they trade on. Growth companies have particular characteristics.
- They are often in developmental stages with growing markets and/or developing technologies.
- They invest earnings back into company growth (development).
- They do not pay out dividends or in any other way share profit with stockholders.
People who invest in high P/E ratio companies are looking for rapidly increasing stock price resulting from internal company growth.
An investor will usually only buy shares in a company whose stock is selling on a very high price/earnings ratio if he expects the company's earnings to increase, which, of course, would automatically make the ratio lower. Typically in bull markets there will be many companies with shares selling at high price/earnings ratios. The stock prices keep going up because people keep buying, and some people keep buying because they see the prices going up. Such stocks are often described as "overvalued," but there may be cases in which the expectations of dramatically higher earnings are justified.