Introduction: The Stock Market’s “Price Tag”
Imagine two smartphones:
- Phone A: ₹50,000 (lasts 5 years).
- Phone B: ₹30,000 (lasts 2 years).
Which is a better deal? You’d compare price vs. longevity.
The P/E (Price-to-Earnings) ratio does the same for stocks—it tells you if a stock is overpriced or a bargain based on its earnings.
But how is it calculated? And how do you use it? Let’s break it down.
What Is P/E Ratio?
The P/E ratio measures a stock’s price relative to its earnings per share (EPS).
Formula:
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P/E Ratio = Current Stock Price / Earnings Per Share (EPS)
- EPS = (Net Profit) / (Total Shares)
Example:
- Stock Price: ₹1,000
- EPS (last 12 months): ₹50
- P/E Ratio: ₹1,000 / ₹50 = 20
Why P/E Ratio Matters?
1. Valuation Check
- High P/E → Stock may be overvalued (or high-growth).
- Low P/E → Stock may be undervalued (or risky).
2. Compare Stocks
- ITC (P/E 25) vs. HUL (P/E 60) → ITC looks cheaper.
3. Market Sentiment
- Nifty 50’s avg. P/E is ~22. Higher = expensive market.
Types of P/E Ratios
1. Trailing P/E
- Uses past 12 months’ earnings (most reliable).
2. Forward P/E
- Based on future earnings estimates (less accurate).
How to Interpret P/E Ratio?
| P/E Range | What It Means | Example Stocks |
|---|---|---|
| <15 | Potentially undervalued/slow-growth | ITC, Coal India |
| 15–25 | Fairly valued | HDFC Bank, Reliance |
| >30 | Overvalued/high-growth | Tesla, Nykaa |
Exceptions:
- High P/E ≠ Always bad (e.g., Amazon had P/E 300+ during growth phase).
- Low P/E ≠ Always good (could signal declining profits).
Limitations of P/E Ratio
❌ Ignores debt – A company may have low P/E but high loans.
❌ Sector bias – Tech stocks have higher P/Es than banks.
❌ Earnings manipulation – Companies can tweak EPS.
Always Combine With:
✔ Debt-to-equity ratio.
✔ Revenue growth.
✔ Industry averages.
P/E Ratio vs. Other Metrics
| Metric | What It Measures | Better For |
|---|---|---|
| P/E | Price vs. Earnings | Mature companies |
| P/B | Price vs. Book Value | Banks, insurers |
| PEG | P/E + Growth Rate | High-growth stocks |
Final Takeaways
✔ P/E = Stock price ÷ Earnings per share.
✔ <15 may be cheap, >30 may be expensive (but check growth).
✔ Compare P/E within the same sector.
✔ Never rely on P/E alone—analyze fundamentals too.
