Many investors are attracted to stocks that appear cheap. A company showing strong growth and high profits, while trading at a low valuation, often seems like a great opportunity. However, a low valuation alone does not guarantee a good investment. Investors must also examine whether the company’s earnings are sustainable in the long run.

A recent example from the semiconductor industry highlights this risk. In June 2026, one of the world’s largest semiconductor companies appeared highly attractive. Its sales had tripled compared to the previous year, and profits had grown even faster. Despite this impressive performance, the stock was trading at a relatively low valuation multiple. Many investors saw it as an ideal combination of strong growth and reasonable pricing.

But the situation changed quickly. Within just five weeks, the company’s share price experienced a sharp decline as investors reassessed the sustainability of earnings. The business itself had not deteriorated significantly. Instead, investors began to question whether its extraordinary profits could continue.

A closer look at the company’s history revealed that the semiconductor industry is highly cyclical. The company’s margins and returns were far above their long-term averages, helped by cyclical industry conditions and unusually favourable pricing and demand dynamics. These conditions boosted profits to exceptional levels that were unlikely to last forever.

As a result, the stock appeared inexpensive on trailing earnings, but those earnings were measured near a cyclical peak and were unlikely to be sustained. When market participants realized, profits could return to normal levels, the valuation picture changed dramatically.

The key lesson for investors is simple: a low valuation can sometimes be a trap. Before deciding that a stock is cheap, investors should evaluate whether current earnings are sustainable. Looking at normal, long-term profit levels rather than peak earnings can help avoid costly mistakes and lead to better investment decisions.

Vinay Paharia, CIO at PGIM India Mutual Fund