So, I was just digging into this article about Dixon Technologies, which, wow, has some incredible revenue growth. But what really jumped out at me was the discussion about its massive P/E ratio. It got me thinking – how should a regular investor like us even approach these high-flying, high-P/E stocks? Should we run for the hills, or is there a smart way to play the high P/E game?

Let’s dive into some specific strategies that, in my experience, can help us deal with high P/E stocks. This isn’t financial advice, of course, just my thoughts and experiences as a fellow investor.

I personally have some very high P/E stocks in my portfolio as well. Those typical FMCG stocks which generally trades at high P/E multiples are one group. Some are the new age companies which have got listed in the last 2-3 years, and currently reports very high P/E multiples mainly due to a small bottom line. I also have those cyclical stocks whose PEs fluctuate from under 10 to 45+ levels depending on their growth cycle.

I have the mix of these and other stocks in my portfolio since many years now. So allow me to share with you the strategy on how to deal with the high P/E stocks.

Strategy 1: The “Growth-at-a-Reasonable-Price” (GARP) Approach

Many of you know, I am not an advocate of buying any company at any price.

It is essential to understand value of a stock to set the margin of safety. Understanding a company’s true worth (its ‘value’) is crucial. If we know the intrinsic value, we can buy it at a discount (a ‘margin of safety’). This discount acts as a cushion, protecting us from losses if our assessment isn’t perfectly accurate, or the market goes down.

Here, I’m not necessarily talking about investing in classic ‘value stocks.’ Value stocks are often mature companies that aren’t growing very fast. Instead, I’m talking about applying a similar principle: finding that ideal middle ground. I am looking for a company that is growing at a good pace but they are not trading at an absurdly high P/E ratio. Basically, we want a stock that is growing well, but not so overpriced that it feels risky.

This is what the ‘Growth at a Reasonable Price’ (GARP) approach is all about.

This is the essence of the Growth at a Reasonable Price (GARP) approach.

With GARP, you look for companies with strong growth potential but also pay attention to their valuation. A P/E of 150 like Dixon? That may be too high. Maybe I will start looking at other companies which have a P/E between 40-70.

• How to Implement: Research companies that are growing rapidly, but have slightly lower P/E compared to some of the most expensive ones. Look for consistent growth in revenue and profit, but do not ignore the valuations. In GAPR investing, investors would focus on EPS growth rate which must complement the high P/E at which the stock is trading. It will use the concept of the PEG ratio to value stocks. If you want to know how to implement the GARP investing strategy, read this article.

Strategy 2: The “Portfolio Allocation” Approach

Alright, let’s be real. High P/E stocks can be incredibly alluring.

The promise of rapid growth, the excitement of being part of the next big thing – it’s hard to resist. And honestly, I don’t think we should completely shut them out either.

However, we must manage our investment in these stocks. The key here, as in most aspects of life, is moderation and strategic thinking. This is why the “Portfolio Allocation” strategy is so important.

The basic idea is simple: don’t put all your eggs in one basket, especially if that basket is made of high-P/E stocks. When you allocate a part of your portfolio to these stocks, you are acknowledging that these stocks come with a higher risk. So, you don’t want to bet everything on them. Instead, you should define your “risk-tolerance”.

Risk tolerance is basically your level of comfort with the possibility of losing money. Are you someone who can sleep soundly even if your portfolio takes a 20% hit in a single day? Or, do you prefer stability and more modest gains? If you are the latter type, then you should have a low allocation to high P/E stocks. I personally like to keep this allocation at below 10%.

In other words, only this part of your portfolio can be volatile. The rest should be reasonably stable.

The rest of your portfolio, according to my strategy, should be built using more dependable assets. I like to mix it up with value stocks – those companies that might not be growing as fast, but are often undervalued and provide a steady base. I also prefer dividend stocks, which can give you a consistent stream of income, regardless of the market fluctuations.

By doing this, we can create a well-balanced portfolio. If the high-P/E stocks go down, the other parts of our portfolio can soften the blow. Our overall portfolio will be less volatile and that will give us some peace of mind.

So, how do you actually implement this?

• First, take a good, hard look at your own risk profile. It depends on several factors, such as your age, income, financial goals, and your mental ability to deal with ups and downs of the market. There is no right or wrong answer here. Read this article to know how to do the risk profile assessment.
• Once you’ve done that, decide on a percentage (maybe between 10-20%, or even less) that you’re comfortable allocating to high-P/E stocks.
• Stick to it, and rebalance your portfolio regularly, which might mean selling some if they grow disproportionately. Or, we can also buy more if other stocks have come down in relative value. This way our portfolio will not only be less risky but also more optimized. If you want to know in more detail about what is portfolio rebalancing, read this article.

The “Portfolio Allocation” approach is about actively managing our risk. It’s about understanding that while high-P/E stocks can be exciting, they shouldn’t dominate our entire investment strategy.

Strategy 3: The “Long-Term Growth Runway” Approach

The “Long-Term Growth Runway” strategy is all about looking far beyond the current financial year and the current hype around a stock.

When you invest in high P/E stocks, you are betting on what the company will become, not what it is today. Since these stocks are already quite highly valued today, the only way to make them work is if they have a long runway for growth.

So what exactly are we looking for?

3.1 Sustainable Growth

First and foremost, we want to see sustained growth potential. This isn’t about a one-time spike in revenue; it’s about a company positioned in a market with long-term tailwinds. Think about industries like renewable energy, artificial intelligence, electric vehicles or even new-age pharma sector. These are spaces with the potential to transform the world in the coming decades. A quality company operating in these sectors can therefore continue to grow for long period of time. If you want to know about quality high P/E stocks, read this article.

For example, if we consider the renewable energy sector, think of a company that manufactures solar panels with high efficiency. While it might have high P/E ratio today, if the company is also investing in R&D to stay ahead of the competition, and if it is operating in a sector which has a huge global demand, its potential for growth could be enormous. In this case, the company is in a great position to grow for many years to come.

Compare this to a company that is currently manufacturing, say, basic non-smart phones. Its growth prospect is limited because the market itself is dying. It doesn’t matter how efficient the company is, or how good their management is, the market will limit their growth.

3.2 Economic Moat

Another key aspect is the “moat,” as I like to call it, a strong competitive advantage that can protect the company from rivals.

This could be a patent, a proprietary technology, or a strong brand name.

For example, a company like Asian Paints, with its huge distribution network and a very loyal customer base, has a very strong moat in India. It is very difficult for new companies to compete with them. You can also read here a more detailed article on fundamental analysis of Asian Paints.

What we can do as an investor?

To implement this strategy, we have to stop looking at next year’s earnings report, and focus on the big picture.

Look at where the company is headed in the next five, ten, or even fifteen years. What is the addressable market? Is the market growing or shrinking? What are the factors that will determine the company’s growth in future? Are they focusing on R&D, or are they just going with the flow?

A Few Examples:

• If you are looking at a biotech company, you must also research what kind of molecules they are developing. Are they unique, or are many other companies working on similar molecules?
• Or, if you are looking at a technology company, are they working on new cutting-edge tech, or are they using a somewhat outdated tech stack?

You need to spend time on research to find these answers. I personally break-down the whole company into six parts: price, growth, profitability, financial health, quality of management, and moat. My Stock Engine app gives me the rating of stocks on all these fronts. In turn, it helps me judge the overall quality of the stock. For example, in the below shown spider diagram (from my Stock Engine), the stocks looks fair in terms of price, management, financial health, and moat, but there are two red flags, on growth front and in profitability of business. It is typical public sector insurance company.

Companies that scores well on all these six fronts gets a high “overall score” of about 75+ (in the scale of 0 to 100). Such companies often show the characteristics of having a “long-term growth runway.”

Strategy 4: The “Backward Integration and Moat” Approach

The “Backward Integration and Moat” strategy is about looking for companies that are not just riding the current wave of growth. But they are are also actively building structural advantages that make their growth more sustainable. They also work to maintain or enhance their profitability over the long term.

Backward integration, simply put, is when a company starts making the components or materials it needs instead of relying on external suppliers. This is a strategy that can lead to higher profitability.

Why backward integration this important?

Well, think about it this way: If a company is dependent on external suppliers, it is at the mercy of their pricing and delivery schedules. Imagine a company making smartphones that relies on a single supplier for crucial components like the display panel or the processor. If that supplier suddenly increases prices, or cannot meet deadlines, the smartphone company’s profits are hit, and their whole production schedule can be messed up.

If you are a high P/E company and have high expectations from the market, such issues can cause great damage to your valuations.

By integrating backwards, the company has greater control over its supply chain, reduce costs, improve product quality and improve its earning.

Example

If you consider the example of Dixon Technologies, mentioned in the original article, you will realize that one of the biggest things they are doing is “backward integration”. They are starting to manufacture their own components. If they are successful, they will not be at the mercy of external suppliers and can improve their profitability.

This strategy not only helps the companies improve their profit margin, but it also creates a “moat” around their business. It is a competitive advantage that makes it harder for new companies to compete with them.

So, how do we implement this strategy when picking high P/E stocks?

• First, we must look at the company’s value chain. Who are its suppliers? Are they relying on a single supplier, or have a multiple vendor strategy? What are the steps they are taking towards backward integration?
  • For example, if you are looking at the electric vehicle (EV) sector, you should try to find companies that are also building battery manufacturing capacity. This will give them an edge in terms of their cost.
  • Or, if you are looking at a pharmaceutical company, look for companies that are also manufacturing their own key ingredients.
• In essence, look beyond the topline, and go deep down into the business to understand where the company is heading.

Strategy 5: The “Incremental Approach”

The “Incremental Approach” is all about being cautious and strategic when entering a position in a high-P/E stock. Instead of diving in headfirst, you dip your toes in the water first.

Let’s say, for example, a high P/E stock seems very promising but also very expensive. You might think the company will grow a lot. But at the back of you mind you also have a nagging doubt if you should invest at that price.

In such a case, this approach could help you manage risk.

Instead of investing your entire planned allocation at once, you break it down into smaller portions.”

• For example, if you were planning to invest Rs.1,00,000 in a stock, you might start by investing small, say just Rs.20,000.
• Then you will wait for the next few quarters (perhaps 2-3) to observe how the company is performing. Are they able to grow their earnings as they have planned? Are there any unexpected events in the market? All these things will give you more clarity.
• If the company’s performance meets or exceeds your expectations, you can then increase your investment to say Rs.30,000. You can continue to increase your allocation incrementally if you continue to be bullish.
• On the other hand, if the earnings are less than you expected, or there are any issues with the company, you can stop investing further. You can even consider selling off a small part of your holding. If you want to know more about the the strategy to consider selling stocks even at a loss, read this article.

This way, you do not put all your capital at risk at once. This approach lets you test the waters, validate your investment thesis, and stay flexible.

This approach is very effective for high-P/E companies because their valuations are already quite stretched. This cautious approach is necessary because any small mistake can cause them to fall.

By doing incremental investment, we can avoid putting all your eggs in one basket, and we are reducing our overall risk.

Strategy 6: The “Stay Informed & Flexible” Approach

The “Stay Informed & Flexible” approach emphasizes that investing, especially in high-P/E stocks, isn’t a “set it and forget it” activity. It demands continuous engagement and a willingness to adapt.

Here’s what that means in practice:

• First, we need to commit to actively following the companies you’ve invested in. This is not just about checking the stock price daily. It means regularly reading their annual reports, listening to their earnings calls, and staying updated on industry news. For example, if a company announces a new product launch, we must study the new product and see whether it is in line with the company’s overall strategy and our expectations. We also need to keep track of management changes. The idea is to stay updated with the news and events to judge any change in competitive advantage of the company.
• Second, we should also be committed to learning about the overall market. What are the new trends? What are the new technologies? Are there any new regulatory changes? All these things can impact not just the company, but also the entire sector. For example, if the government suddenly increases taxes on a particular sector, it can have a negative impact on all companies in that sector.
• Finally, we must be ready to change your investment thesis. This is not an easy thing to do. If your initial hypothesis about the company no longer holds true, you have to be ready to reassess your position. For example, if you think a company was focusing on R&D, but you find out that they are significantly reducing it, you have to reevaluate your decision. If you are not ready to change your mind, your portfolio may suffer.

Conclusion

Investing in high P/E stocks demands a strategic approach, not impulsive action.

1. First, consider the GARP approach, seeking growth at a reasonable price.
2. Then, manage risk by allocating only a small portion of your portfolio to these volatile stocks, diversifying into value and dividend stocks as well.
3. Prioritize companies with a long-term growth runway.
4. The company must also show sustainable competitive advantages like backward integration.
5. If a stock feels expensive, invest incrementally, not all at once.
6. Finally, stay continuously informed, and be flexible, ready to adjust your investment thesis as needed. By adopting these strategies, you can navigate the high-P/E landscape with more confidence and less risk.

Remember, investing is not just about chasing high returns; it is about also managing risks carefully.

Buying a high P/E stocks is a high-risk investing activity. If you are want to take this risk, I think, following the strategies mentioned in this article will lower the risk of loss considerably. In fact, if executed effectively, it can also build tremendous wealth in long-term.

If you found this article useful, please share it with fellow investors or leave your thoughts in the comments below!

Have a happy investing.

Suggested Reading: If you want to know about quality low P/E stocks in India, read this article.