Stock Market · Fundamental Analysis

P/E ratio

The P/E ratio is the most quoted valuation metric in finance. It's also one of the most misunderstood and misused.

What it is

P/E = Market Price per share ÷ Earnings per Share (EPS)

Or equivalently: Market Cap ÷ Net Profit

A P/E of 20 means investors are paying ₹20 for every ₹1 of current annual earnings. It represents how many years of current earnings the market price implies.

> The Indian large-cap benchmark index has historically averaged a P/E of 18–22. Above 25 is considered expensive. Below 15 is cheap. These are rough guides, not rules.

What P/E tells you

High P/E: market expects high growth OR the stock is overvalued.

Low P/E: market expects low growth OR the stock is undervalued.

Context is everything. A P/E of 80 for a company growing 40%/year might be fair. A P/E of 20 for a company shrinking 10%/year is expensive.

Where P/E fails

• No meaning for loss-making companies (negative earnings = meaningless P/E)
• Earnings can be manipulated (PAT can be inflated. See cash flow chapter)
• Doesn't account for debt: a high-debt company may look cheap on P/E but is actually risky
• Doesn't account for growth: use PEG (P/E ÷ Growth rate) for growth comparisons

P/E ÷ Growth ratePEG ratio. PEG below 1 = potentially undervalued growth stock

The P/E trap

Many retail investors buy 'low P/E' stocks without asking WHY they're cheap. A P/E of 8 on a cement company during an infrastructure slowdown means the market expects earnings to fall. The P/E will rise if earnings fall. Called a 'value trap.'

Always pair P/E with growth rate, quality of earnings, and sector context.

Takeaway. P/E = price ÷ EPS. High P/E may indicate growth expectations or overvaluation. Always compare to growth rate (PEG), sector peers, and historical P/E. Cheap P/E can be a value trap.