What is P/E ratio?

The shop analogy

Imagine you are buying a shop from a friend. The shop earns ₹10 lakhs a year in net profit, reliably, year after year. How much would you pay for it?

If you pay ₹1 crore, you are paying 10 times the annual earnings. It would take 10 years of profit to recover your investment. That “10 times earnings” is a P/E of 10.

If the shop also has a new product line that could triple profits in two years, you might pay ₹3 crore — a P/E of 30 — because you are paying for the future, not just the present.

High P/E vs low P/E

A high P/E (say, 50–80×) means investors expect profits to grow fast. They are paying a premium for future earnings. This is common for tech companies, consumer brands in high growth, and anything the market loves right now.

A low P/E (say, 8–12×) can mean two very different things: either the company is cheap and the market is ignoring it (value opportunity), or the market believes earnings will fall and is pricing in that decline (value trap). Distinguishing between these two is the job of fundamental analysis.

When P/E doesn't work

The P/E ratio breaks in three situations, and investors who ignore this get burned regularly.

Loss-making companies. If a company has negative earnings, P/E is undefined or negative. Zomato had no meaningful P/E for years. In these cases you need different metrics (price-to-sales, EV/revenue, or path-to-profitability analysis).

Banks and NBFCs. Banks have very different balance sheet structures. P/E still works, but price-to-book (P/B) and return on equity (ROE) are often more informative.

Cyclical companies. Tata Motors, steel companies, commodity businesses — their earnings swing wildly with the cycle. A steel company at P/E 5 in a supercycle peak is not cheap; those earnings are about to collapse. For cyclicals, analysts prefer EV/EBITDA or look at mid-cycle earnings.

Trailing P/E vs forward P/E

The P/E you usually see quoted is the trailing P/E: current price divided by earnings from the last 12 months. It tells you what the market paid for past earnings.

Forward P/E uses analysts' estimates of the next 12 months' earnings. It tells you what the market is implicitly betting on.

The most important thing the P/E tells you

A P/E does not tell you whether a stock is cheap or expensive in isolation. It tells you what rate of growth the market is currently pricing in.

If Maruti trades at 27× P/E and you believe its earnings will compound at 20% a year for the next 5 years, that's a reasonable price to pay. If you believe earnings will grow at 6%, you are overpaying. The P/E forces you to be explicit about your assumption — and that is its real value.