Understanding P/E Ratio: India's Most Used Valuation Metric

The Sharma Family Investment Debate

At a Diwali family gathering, retired banker Uncle Sharma proclaimed: “I only invest in stocks with P/E below 15. High P/E means expensive, always!”

His son Rohan, a startup founder, disagreed: “Dad, I bought Avenue Supermarts at P/E of 100. It’s up 300%!”

Uncle Sharma scoffed. Rohan smirked.

Who was right? Both – and neither.

P/E ratio is the most commonly used valuation metric in India, but it’s also the most misunderstood. Let’s decode it properly.

What is P/E Ratio?

P/E = Price / Earnings Per Share

It tells you how much investors are willing to pay for ₹1 of a company’s earnings.

Simple Calculation

Example: Reliance Industries

• Current Market Price: ₹2,450
• Earnings Per Share (EPS): ₹98
• P/E Ratio: ₹2,450 / ₹98 = 25x

Interpretation: Investors are paying ₹25 for every ₹1 of Reliance’s annual earnings.

Types of P/E Ratio

1. Trailing P/E (TTM - Trailing Twelve Months)

Uses PAST earnings (last 4 quarters).

Trailing P/E = Current Price / EPS of Last 4 Quarters

Pros: Based on actual, reported numbers Cons: Backward-looking; doesn’t reflect future changes

2. Forward P/E

Uses EXPECTED future earnings (analyst estimates).

Forward P/E = Current Price / Estimated Next Year EPS

Pros: Forward-looking; accounts for growth Cons: Based on estimates; can be wrong

Real Example: Infosys

Infosys looks slightly cheaper on forward P/E because analysts expect earnings growth.

What P/E Actually Tells You

High P/E (Above Market Average)

Could mean:

• Growth Expected: Investors anticipate rapid earnings growth
• Quality Premium: Strong brand, moat, management
• Overvaluation: Stock might be too expensive
• Low Earnings Base: Company recovering from bad period

Low P/E (Below Market Average)

Could mean:

• Value Opportunity: Stock is undervalued
• Structural Problems: Business in decline
• Cyclical Bottom: Industry facing temporary challenges
• Market Pessimism: Often due to sentiment, not fundamentals

Indian Market P/E Benchmarks (2024)

Nifty 50 P/E History

Key Insight: Nifty 50’s long-term average P/E is around 20-22x. Below 18x often indicates opportunity; above 28x suggests caution.

Sector P/E Averages

How to Use P/E for Investment Decisions

Step 1: Compare with Sector Average

Never compare across sectors.

A P/E of 40 for Nestlé (FMCG) is normal. A P/E of 40 for Tata Steel (Metals) is crazy expensive.

Step 2: Compare with Company’s Historical P/E

Example: HDFC Bank

• Current P/E: 18x
• 5-Year Average P/E: 22x
• 10-Year Average P/E: 24x

Interpretation: HDFC Bank is trading below its historical average. Could be value opportunity OR market pricing in slower growth.

Step 3: Compare with Peers

Banking Sector Comparison (2024):

Observation: SBI has lowest P/E but decent ROE. Potential value? Or PSU discount?

Step 4: Check PEG Ratio

PEG = P/E / Earnings Growth Rate

Accounts for growth – a P/E of 50 might be justified if earnings are growing 50% annually.

Example:

• Company A: P/E 30, Growth 30% → PEG = 1
• Company B: P/E 20, Growth 10% → PEG = 2

Company A looks better on PEG basis despite higher P/E.

Real Case Studies: P/E in Action

Case 1: The Value Trap – Yes Bank (2019)

The Numbers:

• P/E: 8x (Looked cheap!)
• Sector Average: 15x

The Reality:

• NPAs hidden
• Management issues
• Governance failures

Outcome: Stock crashed 90%. Low P/E was a WARNING, not opportunity.

Lesson: Low P/E without understanding WHY is dangerous.

Case 2: The Growth Story – Avenue Supermarts (DMart)

The Numbers:

• P/E: 100x+ (Looked expensive!)
• Sector Average: 40x

The Reality:

• Fastest growing retailer
• Asset-light model
• Strong unit economics

Outcome: Stock went up 400% from IPO (2017-2021).

Lesson: High P/E for genuine growth companies can be worth it.

Case 3: The Cyclical Play – Tata Steel (2020-2022)

In 2020:

• P/E: Negative (losses due to COVID)
• Steel prices: Low

In 2022:

• P/E: 4x
• Steel prices: Record high
• Stock up 200%

Wait – P/E of 4x and stock goes up?

Yes! At P/E 4x, earnings were at PEAK. Smart money knew steel prices would fall. By late 2022, steel prices dropped, earnings fell, P/E rose to 15x, and stock corrected.

Lesson: For cyclical stocks, buy when P/E is HIGH (earnings depressed), sell when P/E is LOW (peak earnings).

Common P/E Mistakes Indian Investors Make

Mistake 1: P/E in Isolation

“This stock has P/E of 10, so cheap!”

Without knowing the industry, company quality, and growth prospects, P/E means nothing.

Mistake 2: Comparing Across Sectors

“HDFC Bank at 18 P/E vs DMart at 100 P/E – HDFC is better!”

Wrong comparison. These are different businesses with different growth rates.

Mistake 3: Using P/E for Loss-Making Companies

Zomato in 2021 had negative earnings. P/E was meaningless. Use Price/Sales instead.

Mistake 4: Ignoring Earnings Quality

Company A: ₹100 EPS (from operations) Company B: ₹100 EPS (₹50 from operations, ₹50 from one-time land sale)

Same P/E, but Company A is better quality.

Mistake 5: Not Adjusting for Cycles

Buying commodity stocks at low P/E (peak earnings) is often a mistake.

P/E and Market Timing

When Nifty P/E < 18x

Historically good time to accumulate:

• March 2009: P/E 12x → Massive rally followed
• March 2020: P/E 17x → Best buying opportunity in years

When Nifty P/E > 28x

Time for caution:

• October 2021: P/E 33x → Correction followed
• November 2010: P/E 28x → Years of sideways movement

Where Are We Now? (December 2024)

Nifty P/E: ~22x – Fair value zone. Neither extremely cheap nor expensive.

Beyond P/E: Related Metrics

1. EV/EBITDA (Enterprise Value/EBITDA)

Better for capital-intensive companies. Accounts for debt.

2. Price-to-Book (P/B)

Useful for asset-heavy businesses like banks.

3. Price-to-Sales (P/S)

For loss-making growth companies (Zomato, Nykaa).

4. Dividend Yield

For income-focused investors.

Quick Guide: Which Metric for Which Sector?

P/E Data Sources

Free Resources

How to Check on Screener.in

1. Go to screener.in
2. Search company name
3. Check “Stock P/E” in summary
4. Go to “Peer Comparison” for sector context

Action Steps for Investors

For Beginners

1. Start tracking Nifty 50 P/E weekly
2. Compare any stock’s P/E with sector average before buying
3. Avoid stocks with P/E 5x+ higher than sector without clear reason

For Intermediate Investors

1. Use PEG ratio for growth stocks
2. Check trailing vs forward P/E for context
3. Understand cyclical vs structural P/E movements

For Advanced Investors

1. Build P/E band analysis (5-year high/low)
2. Combine with EV/EBITDA for deeper analysis
3. Create sector rotation strategies based on relative P/E

Risk Disclaimer

P/E ratio is one of many tools for stock analysis. A low P/E doesn’t guarantee good returns, and a high P/E doesn’t mean certain losses. Stock investing involves risks including capital loss. This content is for educational purposes only. Consult a SEBI-registered advisor before making investment decisions.

Summary

P/E ratio tells you what investors pay per rupee of earnings. But context is everything:

• Compare within sectors, not across
• High P/E might be justified by high growth
• Low P/E might be a trap if business is declining
• Cyclical stocks work in reverse – buy high P/E, sell low P/E
• Use alongside other metrics like PEG, P/B, EV/EBITDA

Uncle Sharma’s rule and Rohan’s approach both have merit. The key is knowing WHEN each applies.

Social Media Posts

LinkedIn: “Just realized I’ve been using P/E ratio wrong for years. Low P/E ≠ cheap. High P/E ≠ expensive. Context matters: 1) Sector comparison 2) Growth rate 3) Earnings quality 4) Business cycle. Which P/E mistake have you made? #Investing #ValueInvesting”

Twitter/X: “P/E Ratio Cheat Sheet: 📊 Below 15: Value OR value trap 📈 15-25: Fair value for most sectors 📉 25-40: Growth stocks or FMCG 🚀 40+: Needs strong growth justification

But ALWAYS compare within the same sector! #StockMarket #Valuation”

Instagram: “Your uncle: ‘Never buy stocks above P/E 15!’ Reality: DMart at P/E 100 → 400% returns

The truth about P/E ratio: ✅ Good for comparing similar companies ❌ Useless across different sectors ✅ Low P/E in cyclicals = SELL signal

Save this before your next investment! 💡 #PERatio #StockMarketBasics”