The price-to-earnings (P/E) ratio is a popular stock valuation metric that compares a company’s current share price relative to its earnings per share (EPS). Investors use it to assess how much they are paying for every rupee of a company's earnings.
The P/E ratio of the NIFTY 50 declined from 21.4 to 19.6 by the end of March 2026, according to the SEBI Annual Report 2025–26. This indicates a decline in the index's valuation multiple during the period, but it does not necessarily mean that every Indian stock became more affordable.
Continue reading to learn what is a PE ratio and how it benefits investors.
What is a PE Ratio: Meaning, Formula and Example
The PE ratio compares a company's stock price to its earnings per share. It helps investors understand how much the market is willing to pay for each rupee of the company's earnings. They pair it with other metrics and use it to value stocks.
According to the Financial Express, the average PE of companies listed in 2026 has gone down by almost 40% due to a volatile market. This indicates a significant valuation correction and a shift toward investor pragmatism amid volatile market conditions. Besides, companies’ expectations have become moderate due to increasing investor caution and low equity returns.
Formula of the Price-to-Earnings Ratio
Investors calculate the ratio by dividing a company’s current stock price by earnings per share in the last year.
Don’t know what is EPS? It refers to Earnings Per Share and is the net profit a company earns for each share of its common stock. The formula to calculate EPS is:
(Net Income - Preferred Dividends) ÷ Weighted Average Common Shares Outstanding
Example of P/E Ratio
It will be easier for you to understand what is a PE ratio with the example below,
Suppose a stock is trading at ₹100, and the company earned a profit of ₹20 per share last year.
Therefore:
P/E Ratio = ₹100 ÷ ₹20
= 5
This means an investor pays ₹5 for every ₹10 of annual earnings.
Note: A P/E ratio of 5 does not automatically mean that the stock is undervalued. Investors must also consider the company's growth prospects, financial position, industry conditions and historical valuation.
What are The Different Types of P/E ratio?
The two primary types are Trailing and Forward P/E Ratios. While the former depends on the actual past earnings in the last 12 months, the latter depends on the estimated earnings in the upcoming 12 months.
Since you now know what is a PE ratio take a look at the table below:
5 Common Ways Investors Use PE Ratio to Find Good Stocks
EPS growth slowed sharply to 1.3% year-on-year, marking its weakest level since April 2021. It shows a drastic fall in corporate earnings momentum. However, Indian investors need to understand what is a PE ratio to find good stocks.
Some common uses of the ratio for investors are mentioned below:
Compare With Historical Averages
A basic step an investor starts with when choosing stocks for investment is comparing the current valuation of a stock with its historical range.
If the current P/E ratio is lower than the historical range, it indicates the following:
- The stock is trading at a relatively lower valuation than before.
- Investors have become cautious about the company's future earnings
If the current P/E ratio is higher than the historical range, it indicates the following:
- Investors expect stronger future earnings growth.
- Market optimism has pushed the stock's valuation higher.
However, investors need to understand that various reasons can cause a shift in the existing ratio and historical ratio. So, it is advisable not to choose a stock solely based on the difference in its ratio.
Investors using the ratio before buying stocks can use online trading apps like the Stoxkart Mobile Trading App to view metrics of a specific company’s stock, including trailing P/E and forward P/E.
Compare With Industry Peers
P/E ratios largely depend on the industry and sector. Generally, high-growth sectors such as technology have a higher ratio. Slow-growth sectors such as utilities have lower ratios. If the market sector is broad, each industry has a different ratio. Investors compare a company’s ratio to its peers in the same industry or sector to evaluate whether it is reasonable.
Since you understood what is a PE ratio, you might be wondering, “What do a high ratio and a low ratio indicate?” The table below mentions the primary differences:
Set Earnings Expectations
A higher ratio indicates earnings will grow, and vice versa. Besides, evaluating earnings forecasts also helps determine whether the stock is unwarranted or justified. The former can make the stock more susceptible to shifting.
Investors can use the ratio to assess earnings expectations in the following ways:
- Calculate the forecasted growth rate the market expects from the company.
- Consider the long-term historical PE average to calculate future earnings trajectory.
- If the forward PE is less than the trailing PE, investors expect earnings to grow.
For Stock Valuation
Recent trends, investor sentiment, and news flow greatly influence the market. As a result, investors make financial decisions based on current market levels and ignore underlying fundamentals. The PE signal evaluates the current market’s condition.
Two ways investors use it for stock valuation are:
- Examine the NIFTY 50 P/E ratio to understand how the index is valued relative to its earnings.
- Compare a company's P/E ratio with its earnings growth, financial performance and industry peers.
Broad Market Benchmarking
Often, investors use the P/E ratio of a stock for broad market benchmarking by comparing it with major market indexes like the S&P 500. So, what is broad market benchmarking in the stock market? It is a practice through which investors evaluate a stock’s risks, performance or returns by comparing it with a broad market index.
The two types of broad market benchmarking used by investors are:
- Market Premium helps determine whether a stock is cheaper or more expensive than the ‘average’ market.
- Macro Environment is when high overall index P/Es indicate an overextended or frothy market.
What are the Limitations of the P/E Ratio?
Simply knowing what is a PE ratio and its benefits might not be sufficient for investors. You have to know its limitations as well and rely on a trustworthy trading platform. Some of the common limitations are:
- It does not ensure future growth. A high ratio just indicates that investors expect future earnings to increase rapidly.
- The ratio is not beneficial for startups with negative earnings, as the ratio is undefined if there are zero earnings.
- It ignores debt or financial risks, as it does not consider how much risk the company can carry.
- The ratio is defined by a country’s accounting standards and depends on reported net income. So, companies listed on the stock exchange and reporting profits might still not earn cash.
Final Thoughts
So, what is a PE ratio? It is a powerful tool to assess the market value of a company’s earnings. However, investors should not solely rely on it when investing. Other technical analysis indicators they should consider are the weighted average cost of capital and discounted cash flow.
It can be useful for comparing stocks, evaluating historical valuations, understanding market expectations and assessing whether a company's share price appears reasonable relative to its earnings.
