6.2What is the P/E ratio?
The Price-to-Earnings (P/E) ratio tells you how many rupees investors are paying for every ₹1 of the company’s yearly profit.
It is the most common way to judge whether a share is "expensive" or "cheap" relative to its profits.
A shop earns ₹1 lakh profit a year. If someone pays ₹20 lakh to buy it, they are paying 20 times its yearly profit: a P/E of 20. It would take 20 years of profit to earn back the price (if profit never grew).
Investors expect strong future growth, or the stock may be overpriced.
The market expects slow growth or problems, or the stock may be undervalued.
Neither by itself. A lower P/E is cheaper only if growth and quality are similar. Compare within the same industry.
- Price = ₹1,500; EPS = ₹60.
- P/E = 1,500 ÷ 60 = 25.
- Useless when profits are negative or temporarily depressed.
- Different industries have very different normal P/Es (IT vs banks vs FMCG).
- Based on past profits; the future may differ.
Always compare a ratio with (1) the company’s own history and (2) other companies in the same industry. A single number on its own means little.
- P/E = price ÷ EPS.
- High P/E = high expectations.
- Compare with peers and history.
Q1. Price ₹800, EPS ₹40. P/E?Show answer
20.
Q2. Is a P/E of 10 always better than 40?Show answer
No. It depends on growth, quality and industry.
Q3. Why can’t you use P/E for a loss-making company?Show answer
EPS is negative, so P/E is meaningless.