Level 6 · Financial Ratios
P/E Ratio
The most quoted ratio in the market, and the most misunderstood.
In this lesson
What you'll be able to do
- Calculate the P/E ratio
- Explain what a high or low P/E implies
- Distinguish trailing from forward P/E
- Know when P/E is useless
Think about it
Two companies earn exactly the same profit, but one is priced three times higher. Why would anyone pay that?
Story
Let's picture it
Two identical shops earn ₹10 lakh a year. The first sits in a fading market lane. The second sits beside a new metro station where footfall is rising every month. A buyer happily pays ₹1 crore for the second and only ₹40 lakh for the first. Same profit today, different expectations about tomorrow.
Visual
Reading a P/E
Take the share price
The current market price of one share
Divide by EPS
Earnings per share for the last 12 months
Get the multiple
How many rupees you pay per rupee of annual profit
Compare
Against the company's own history and its true peers only
Plain English
The simple explanation
P/E is share price divided by earnings per share. A P/E of 20 means you are paying ₹20 for every ₹1 of annual profit the company currently earns.
A high P/E is not automatically expensive and a low P/E is not automatically cheap. High usually reflects expectations of strong future growth; low can reflect either genuine undervaluation or genuine problems.
P/E breaks completely when earnings are negative, unusually depressed, or inflated by one-off gains. In those cases the ratio is arithmetic without meaning.
Real world
Indian FMCG vs metals
Consumer goods companies in India have long traded at far higher P/E multiples than metal producers. This is not a mispricing, it reflects earnings stability versus commodity-cycle volatility. Comparing the two directly would be meaningless.
Watch out
Common mistakes
- Assuming low P/E means cheap.
- Comparing P/E across unrelated industries.
- Using P/E when earnings are negative or one-off inflated.
Did you know?
The inverse of P/E is the earnings yield, a P/E of 25 corresponds to an earnings yield of 4%, which makes comparison with bond yields possible.
Your turn
Mini challenge
Find one company's current P/E and its 5-year average P/E. Which is higher, and can you explain why?
Quick quiz
1 / 5
Wrap up
Summary
P/E tells you how many rupees the market pays per rupee of current profit. Use it against a company's own history and its genuine peers, never across sectors, never with broken earnings.
- P/E = price ÷ EPS
- It prices expectations
- Compare within sector and against own history
- Useless with negative or one-off earnings
Revise