What does the PE ratio tell you about a mutual fund?

Investors tend to attach much importance to the price-to-earnings (PE) ratio and market capitalisation of a stock while buying. When used in conjunction with other metrics, these numbers can help in picking the right stock at the right time. But can they also help select the right mutual funds? You may find it difficult to ascertain the investing style and preferences of the fund manager only by looking at the fund portfolio. This is where the fund's PE ratio and average market capitalisation become good reference points .

It is the average of the PE of all the stocks that make up the fund's portfolio, in proportion to their allocation within the portfolio. A high portfolio PE would indicate that the scheme mostly holds stocks that are quoting a valuation premium. This indicates a preference for growth oriented businesses. In a growth based approach, the fund manager does not shy away from paying a high price for stocks that are exhibiting healthy growth in profitability.Growth oriented funds tend to exhibit strong returns within a short span of time but are more volatile. Value conscious funds typically yield great results over a longer period of time and come with lesser volatility in returns.

"If a mid-cap fund is carrying a lower market capitalisation than its peers, it suggests the fund manager has dug deeper into mid-and-small cap universe of stocks and is indicative of higher level of aggression." Similarly, a large-cap fund with a much higher average market capitalisation relative to peers implies the fund is more of a pure-play large-cap fund. 

A higher average market capitalisation within the mid-cap funds category would suggest the fund manager's preference for nascent large-caps rather than pure mid-caps, while a lower valuation would imply a value-driven strategy. The Franklin India Prima Fund, for instance, has a market capitalisation closer to its category average but a lower PE, suggesting a valuation conscious approach.

Source(ET Wealth)