If you’re new to investing, you’ve probably heard the term PE Ratio thrown around a lot. But what exactly does it mean, and how can it help you make better investment decisions?
As someone who has spent years analyzing stocks and writing about finance, I can tell you that the PE Ratio is one of the most useful—and misunderstood—metrics in the stock market. In this guide, I’ll break it down in plain English, explain how to use it, and reveal what a good PE Ratio really looks like.
What is the PE Ratio?
The PE Ratio (Price-to-Earnings Ratio) tells you how much investors are willing to pay for each rupee of a company’s earnings. It’s a simple but powerful way to check if a stock is overpriced, underpriced, or fairly valued.
How is the PE Ratio Calculated?
The formula is straightforward:
PE Ratio = Current Stock Price ÷ Earnings Per Share (EPS)
For example, if a company’s stock price is ₹500 and its EPS is ₹25, then its PE would be 20. This means investors are paying ₹20 for every ₹1 the company earns.
Why Does the PE Ratio Matter?
When I first started investing, I ignored the PE Ratio—big mistake. Here’s why it’s so important:
- Helps Compare Stocks
- You can’t compare stock prices directly (a ₹100 stock might be cheaper than a ₹50 stock). The PE Ratio lets you compare companies fairly.
- Identifies Overvalued & Undervalued Stocks
- A high PE Ratio could mean the stock is expensive.
- A low PE Ratio might mean it’s a bargain (or there’s a hidden problem).
- Shows Market Expectations
- A rising PE Ratio means investors expect faster growth.
- A falling PE Ratio suggests declining confidence.
Types of PE Ratios
Not all PE Ratios are the same. There are two main types:
1. Trailing PE Ratio
- Based on past 12 months’ earnings.
- More reliable because it uses real data.
Example:
If Reliance Industries earned ₹80 per share last year and its stock price is ₹2,400, its Trailing PE is 30 (2400 ÷ 80).
2. Forward PE Ratio
- Based on future earnings estimates (analyst predictions).
- Useful for growth stocks but less accurate.
Example:
If Tata Motors is expected to earn ₹50 per share next year and trades at ₹600, its Forward PE is 12 (600 ÷ 50).
What is a Good PE Ratio?
This is the million-dollar question. The truth? There’s no perfect PE Ratio, but here’s a general rule of thumb:
| PE Range | What It Means | Example Stocks |
|---|---|---|
| Below 15 | Could be undervalued (or in a slow-growth industry) | PSU Banks, FMCG |
| 15-25 | Fairly valued (common for stable companies) | HDFC Bank, ITC |
| Above 30 | Expensive (unless high growth expected) | Tech startups, Tesla |
Key Exceptions:
- High PE Stocks (50+): Companies like Tesla or Nykaa trade at high PEs because investors expect explosive growth.
- Low PE Stocks (<10): Sometimes, a low PE means the company is struggling (like Vodafone Idea).
Pro Tip: Always compare a stock’s PE with its industry average—not just the number itself.
How to Use the PE Ratio Wisely
From my experience, here’s how smart investors use the PE :
1. Compare Within the Same Sector
- A PE of 25 might be normal for a tech stock but expensive for a bank.
2. Check Historical PE Trends
- If a stock’s PE is much higher than its 5-year average, it might be overpriced.
3. Combine with Other Metrics
- PEG Ratio (PE ÷ Growth Rate) – Better for fast-growing companies.
- Debt Levels – A low PE means nothing if the company is drowning in debt.
- Profit Margins – High margins justify a higher PE.
Limitations of the PE Ratio
While useful, the PE isn’t perfect. Here’s why:
❌ Ignores Debt – A company with high debt may look cheap but be risky.
❌ Useless for Loss-Making Companies (No earnings = No PE).
❌ Earnings Can Be Manipulated – Some companies tweak EPS to make PE look better.
That’s why I always say: Never rely only on the PE.
Real-Life Example
Let’s say you’re comparing HDFC Bank and Yes Bank:
| Stock | Price (₹) | EPS (₹) | PE Ratio |
|---|---|---|---|
| HDFC Bank | 1,500 | 75 | 20 |
| Yes Bank | 20 | 2 | 10 |
At first glance, Yes Bank looks cheaper (PE 10 vs. HDFC’s 20). But HDFC Bank has stable profits, while Yes Bank has a history of losses. This shows why PE alone isn’t enough—you need deeper research.
FAQs on PE
What is a good PE ratio?
A good PE ratio is usually between 10-20. Lower than 10 may be cheap (but check why). Higher than 25 can be expensive (unless growing fast). Always compare to similar companies.
Is a PE ratio of 40 good or bad?
A PE ratio of 40 is generally considered high, but whether it’s “good” or “bad” depends on:
Growth: May be justified if earnings are growing rapidly (e.g., tech startups).
Industry: Normal for sectors like software (e.g., SaaS companies often have 40+ PE).
Alternatives: Bad if similar companies trade at lower PEs with equal growth.
Rule of thumb:
Good if profits are expected to double soon.
Bad if growth is slowing or earnings are unstable.
Example: A PE of 40 for a stable utility stock = overpriced. For a fast-growing AI company = possibly fair. Always compare to peers!
Is higher EPS better?
Yes, generally a higher EPS (Earnings Per Share) is better, but with important caveats:
Why Higher EPS is Good:
Profitability Signal → Means the company earns more per share.
Investor Returns → Companies with rising EPS often pay dividends or reinvest for growth.
Stock Price Boost → EPS growth typically drives share prices up over time.
When Higher EPS Isn’t Better:
If from cost-cutting (e.g., layoffs) instead of revenue growth.
If EPS is artificially inflated (e.g., share buybacks reducing outstanding shares).
If debt increases to boost earnings (risky long-term).
What is a good ROE?
A good ROE (Return on Equity) typically falls between 15-20% or higher, but context matters. Here’s a quick breakdown:
ROE Benchmarks
<10%: Weak (may indicate poor profitability or inefficient management).
15-20%: Solid (common for stable, well-run companies).
20-30%+: Excellent (often seen in high-performing or capital-light businesses).
What is a good dividend yield?
A good dividend yield depends on your investment goals and market conditions, but here’s a simple guide:
Dividend Yield Benchmarks
2–4%: Average (common for stable, blue-chip stocks like HUL or Infosys).
4–6%: Attractive (often found in mature sectors like FMCG or utilities).
6%+: High (could signal value—or risk—e.g., PSU stocks like ONGC).
Conclusion: Should You Buy Low PE Stocks?
After years of analyzing stocks, here’s my take:
✅ Low PE Stocks can be great bargains—if the company is fundamentally strong.
✅ High PE Stocks can still be good buys—if growth justifies the price.
The PE Ratio is like a speedometer—it tells you how fast you’re going, but you still need to watch the road. Combine it with other tools, and you’ll make much smarter investing decisions.
