Why would a investor buy shares in a company that was selling on a very high P/E ratio?

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M.P. Ossa | College Teacher | (Level 1) Distinguished Educator

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Buying shares in a company that is selling stock at a high price-to-earnings ratio is a practice often attributed to risk-taking investors because all economic conditions cannot be maintained at equilibrium, thus high P/E growth stocks may involve risk. On the whole though, companies with high P/Es have lower risk. The P/E ratio is the value of a company in terms of a comparison between market price traded and earnings received: the P/E compares the value as seen by buyers and the value as based on real performance shown by earnings.

A company with high P/E is generally a company with high growth and an expectation of continued high growth. "Growth" means that earnings are increasing and that profit is being employed in growth reinvestment instead of being dispersed in dividends. This is of interest to investors because continued growth usually equates to continued increase in market price. Investors who want stocks that show growth and growth potential and who are not interested in income from dividends will choose companies with high P/E ratios.

According to Richard A. Brealey and Stewart C. Myers in Principles of Corporate Finance,

The high P/E shows that investors think that the firm has good growth opportunities, [or] that its earnings are relatively safe and deserve a low capitalization rate, or both.


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