The Price-to-Earnings (PE) ratio is one of the most widely used tools for valuing stocks. It helps investors understand whether a stock is overpriced, undervalued, or fairly valued compared to its earnings. For Indian investors, learning how the PE ratio works is an essential part of making informed investment decisions.
If you are just beginning your analysis journey, you may want to read our guide on how to analyse a company before investing.
What Is the PE Ratio?
The PE ratio shows how much investors are willing to pay for ₹1 of a company’s earnings. It is calculated as:
PE Ratio = Share Price ÷ Earnings Per Share (EPS)
This ratio reflects market expectations about the company’s growth, stability, and profitability.
Types of PE Ratios
1. Trailing PE
- Based on earnings from the last 12 months (historical data)
- Most commonly used
2. Forward PE
- Based on projected future earnings
- Useful for analysing growth companies
Why the PE Ratio Matters
- Helps compare companies within the same industry
- Indicates whether a stock is undervalued or expensive
- Useful for long-term investment decisions
- Reflects market expectations about growth and stability
How to Interpret the PE Ratio
1. High PE Ratio
- Indicates higher market expectations
- Often associated with growth-oriented companies
- May also indicate overvaluation
2. Low PE Ratio
- May indicate undervaluation
- Could also signal weak growth or financial issues
- Often seen in cyclical or mature industries
PE Ratio Benchmarks in India
The interpretation of PE varies by industry. For example:
- IT and FMCG sectors usually trade at higher PE ratios due to stable growth
- Banking and metal sectors often trade at lower PE ratios
- Small caps may show very high or very low PEs depending on volatility
You can check industry-specific PE benchmarks on NSE India or financial research platforms.
PE Ratio vs Growth: The PEG Ratio
The PEG ratio helps determine whether a high PE is justified by future earnings growth.
PEG Ratio = PE Ratio ÷ Expected EPS Growth Rate
- PEG below 1 may indicate undervaluation
- PEG above 1 may indicate overvaluation
- Useful for growth-oriented companies
Limitations of the PE Ratio
- Does not work well for loss-making companies
- Does not consider debt levels
- Can vary widely between industries
- Can be misleading during short-term market volatility
How to Use PE Ratio for Real Analysis
1. Compare With Industry Peers
- A company should be compared only with companies in the same sector.
2. Study Long-Term Historical PE
- A company’s historical PE range helps assess current valuation.
3. Consider Growth Prospects
- A high PE may be justified if future growth is strong.
4. Combine With Other Ratios
- Use along with ROE, Debt-to-Equity, and profit margins for complete analysis.
PE Ratio Example
Suppose a company trades at ₹500 per share and has an EPS of ₹25.
PE Ratio = 500 ÷ 25 = 20
A PE of 20 means investors are willing to pay ₹20 for every ₹1 of earnings. To judge whether this is high or low, compare it with industry peers.
When PE Ratio Is Most Useful
- For analysing stable and profitable companies
- During long-term equity research
- When comparing companies within the same industry
For deeper company analysis, you may read our fundamental analysis guide.
Final Thoughts
The PE ratio is a powerful yet simple tool for evaluating stock valuations. While it helps investors understand whether a stock is cheap or expensive, it should be used alongside other financial metrics and industry research. With proper interpretation, the PE ratio becomes an essential part of disciplined and informed investing.
SEBI Compliance and Legal Note
This article is for educational purposes only and not financial advice.
Data references from SEBI, NSE, and BSE.
Investors may use the SEBI SCORES platform for complaints or support.
Consult a SEBI-registered advisor before investing.