Ask Matt: Does a low P-E mean stock will go up?

• Academic studies have supported that stocks with the lowest price-to-book ratios fare best over time
• Betting on stocks with low P-E ratios has worked handsomely this year so far
• But there's no guarantee low P-E stocks will be winners long term and exceptions can be costly

USA TODAY markets reporter Matt Krantz answers a different reader question every weekday. To submit a question, e-mail Matt at mkrantz@usatoday.com.

Q: If a stock has a low P-E, does that mean it's going to go up in the future because it's cheap?

A: Investors love a bargain. And for good reason.

Academic studies have shown beat-up "value" stocks do best over time. Most academic studies define beat-up stocks as those of companies with the lowest prices relative to the book value, or net worth.

But for many investors, the concept of the P-E ratio, or price-to-earnings, is what defines a cheap stock. A stock with a low P-E is one that investors aren't paying much for a claim to the company's earnings. Some investors think that if they buy a stock with a low P-E ratio, they're getting the asset cheap, and it's likely to gain in the future.

And that strategy definitely worked in 2012. Investors who bought the 10 stocks in the Standard & Poor's 500 index with the lowest trailing P-E ratios at the end of 2011 would be up handsomely. On average, these 10 stocks have risen 27.8% this year, handily topping the 12.4% gain of the S&P 500.

The winners among the stocks with the low P-Es have been overwhelming. Of the 10 stocks with the lowest P-E ratios at the end of 2011, nine of them ended higher in 2012. The biggest gainer was Discover Financial, which rose 70.8%.

But like many short-term trends, there's no guarantee this one will pay off going forward. Much of the gains of the stocks are tied to rallies in their industries. Four of the top 10 stocks with the low P-E last year are in the energy sector, and five in financials.

Meanwhile, evidence on whether the P-E ratio is a indicator of future price gains longer term is mixed. And there have been exceptions this year, too. Coal producer Cliffs Natural had one of the lowest P-Es at the end of 2011, and this year the stock has fallen 42%.