Introduction

The price-to-earnings (P/E) ratio is one of the most utilised measures for pulling apart stocks for Indian investors. Whether you are looking at a blue-chip heavyweight like Reliance Industries or a rapidly growing company like Zomato, the price-to-earnings (P/E) ratio, simply price divided by earnings per share (EPS), is arguably the most often used piece of information found when looking at a stock and used as a simple means to determine whether a stock is over or under valued. A relatively low P/E ratio can suggest hidden "value" when viewed in the context of a similar P/E ratio of other companies in the same sector. In contrast, a relatively high P/E ratio may only say that the market is willing to pay a premium for a known brand or stock with a significant growth path. The P/E ratio can be misleading if interpreted incorrectly, tricking many investors relying on one measure. Indian investors operating in the often-uncertain values of the BSE and NSE need to understand the issues with the P/E ratio to make sensible decisions about stocks.

The Basics of the P/E Ratio

A P/E ratio tells investors how much they are willing to pay for every rupee of a company's earnings. For example, if Tata Motors has a price of ₹800 and earnings per share (EPS) of ₹40, it has a P/E of 20, which suggests that investors are paying ₹20 for every ₹1 of earnings. Indian investors use P/E ratios to compare companies against market averages like the Nifty 50 (average about 22 in early 2025) to find potential investment candidates.

There are two basic types of P/E ratios: historical or trailing versus forward. Both are widely reported but use different calculation methods and have problems that can mislead an investor if not carefully considered.

Historical Data Doesn’t Predict the Future

The trailing P/E ratio is based on a company's earnings over the past twelve months. This is an actual number, but it can be misleading for companies that operate in fast-changing industries like technology and renewable energy. For example, take a company like Adani Green Energy. They may have a high trailing P/E because of their heavy investment in infrastructure, which would reduce current earnings and signal an increase in prospects. Relying solely on historical earnings disregards the information the historical earnings are signalling, which can cause investors to miss out on great stocks completely.

A low trailing P/E does not always mean it is a bargain. For example, a traditional manufacturing company facing declining demand could signal future growth issues rather than being undervalued. Therefore, Indian investors need to consider more than just historical earnings; they must also consider factors like India's push into green energy or digital transformation, which can change a company's long-term earnings.

Forward P/E and the Risk of Optimism

The forward P/E ratio, which is based on analysts' earnings predictions, is well-suited for growth-focused companies such as those in India's IT sector (for example, Infosys or TCS). However, projections can be very speculative and differ greatly, particularly considering a company like Paytm, which may have overly optimistic forecasts (indicated by an exorbitant forward P/E). Depending on the value derived from the forward P/E in India, it would be a debacle, particularly as market sentiments can be heavily influenced by next policy decisions or global economic movements, leading to valuable mistakes when using this measure too extensively.

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Industry Differences Matter

P/E ratios vary significantly across sectors, a critical factor for Indian investors. Technology and consumer internet companies, such as Zomato or Nykaa, often have high P/E ratios (sometimes 50 or more) due to expectations of rapid growth. In contrast, sectors like banking (e.g., HDFC Bank) or utilities typically have lower P/Es (around 15–20) due to stable but slower growth. Comparing the P/E of a tech startup to that of a public sector bank like SBI is meaningless without considering industry dynamics. Indian investors must benchmark P/E ratios against sector peers and market conditions, such as India’s post-2024 economic recovery, to draw meaningful conclusions.

Misinterpreting High and Low P/Es

A high P/E ratio doesn’t always mean a stock is overpriced. For example, in 2024, Zomato’s P/E was significantly higher than Maruti Suzuki’s, reflecting investor confidence in Zomato’s growth in India’s booming food delivery market. Conversely, a low P/E might signal trouble. A company like Vodafone Idea, with a low P/E, may appear cheap but could grapple with debt and competitive pressures in India’s telecom sector. Indian investors must dig deeper, examining factors like debt levels, cash flow, and market share, to avoid being misled by P/E alone.

Conclusion

The P/E ratio can be a useful starting point for investors in India, but it is not a crystal ball. The P/E ratio is based on actual or expected earnings, can be influenced by different approaches to accounting, and differs from sector to sector. Knowing its limitations and using the P/E ratio in conjunction with some broader measures will allow investors to access the lively Indian stock market more confidently. Investing in established names like Reliance or emerging players such as Ola Electric, using the P/E ratio cautiously and in context, will help you make better decisions in 2025 and beyond.

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