Meera runs a chai shop near a college campus in Nagpur.

Every month, she makes ₹10,000 in profit. Consistent. Reliable. The shop has been running for four years. Nothing dramatic. Just ₹10,000, month after month.

One day, her neighbour Ramesh offers to buy the shop.

He says:
"I'll pay you ₹1,20,000 for it."

That's 12 months of profit. A fair price. Meera thinks about it.

Then, two weeks later, a real estate developer announces a new mall coming up 200 metres from her shop.

Suddenly, three more people want to buy Meera's chai shop.

The offers jump — ₹2,40,000. Then ₹3,60,000.

The profit hasn't changed.

Still ₹10,000 a month.
Still the same chai.
Same customers.
Same stove.

What changed?

How excited people are about the future of that shop.

That excitement — the gap between what a business actually earns and what someone is willing to pay for it — has a name in the stock market.

It's called the Price-to-Earnings Ratio.
Or PE Ratio.

PE Ratio = Price per Share ÷ Earnings per Share

In Meera's case:

If you think of each ₹1,000 of annual profit as one "share" of earnings, and someone pays ₹3,60,000 for ₹1,20,000 of annual profit — that's a PE of 3.

When the mall was announced, and the price jumped to ₹3,60,000 for the same ₹1,20,000 profit, the PE became 3.

When Ramesh first offered ₹1,20,000, the PE was 1.

Same shop.
Same earnings.
Different PE.

Because the PE measures what people are willing to pay per rupee of earnings, not what the earnings actually are.

Good sign:
A PE that's reasonable relative to how fast the business is growing.

Bad sign:
A PE that's priced for a future the business can't actually deliver.

Why it matters:
Because you're not just buying today's earnings.
You're buying the price the market has put on all the future earnings it expects.

The simple version says:

Low PE = cheap stock.
High PE = expensive stock.

That's not wrong.

It's just incomplete in a specific way that costs money.

A stock with a PE of 7 looks cheap.

But if earnings are falling — say, from ₹50 per share three years ago to ₹22 per share today — the price didn't drop because the market was being irrational.

The price dropped because the market is anticipating further earnings deterioration.

The PE looks cheap because the price has already fallen.

But the E in that ratio is about to fall further.

Suddenly, the PE isn't 7 anymore.

It's 14.

And the stock has already dropped 40%.

This is not a rare edge case.

It is one of the most common ways retail investors lose money on "statistically cheap" stocks.

A PE of 60 sounds expensive — until you see a company growing earnings at 35% per year.

At that growth rate, earnings will roughly double in about 2.5 years.

In five years, today's "expensive" PE might look like a bargain on tomorrow's earnings base.

This is why serious investors don't compare PE ratios across industries without adjusting for growth.

A bank trading at PE 10 is not automatically cheaper than a software company trading at PE 45.

The businesses are structurally different.
The earnings are structurally different.

The comparison is meaningless without context.

Using PE as a shortcut to avoid doing the harder work of understanding:

When I'm screening using PE, the ratio is a filter — not a conclusion.

The first thing I'm checking is not whether the PE is high or low.

It's whether the earnings number in the denominator is clean.

Reported earnings in Indian listed companies can include one-time items:

These inflate the E temporarily.

A PE of 14 built on a year that included ₹40 crore of non-recurring income is not the same as a PE of 14 built on steady operating profit.

I strip those out before I trust the ratio at all.

The second thing I'm watching is the direction of earnings over the last six to eight quarters, not just the trailing twelve months.

A company with:

is a different conversation than a company with:

The snapshot PE is the same.

The underlying story is not.

And this is where I've made the most mistakes.

I pay attention to what kind of PE expansion is happening in the sector, not just in the stock.

Between 2020 and 2022, multiple mid-cap consumer names in India saw PE ratios expand from 25x to 45x without a commensurate improvement in earnings growth.

That wasn't the businesses getting better.

That was liquidity looking for a home.

I've learned to treat sector-wide PE expansion with more suspicion than single-stock PE expansion.

When an entire sector re-rates simultaneously, the more likely explanation is sentiment, not suddenly improved fundamentals across 15 companies at once.

The number I actually care about when using PE is not the PE itself.

It's the earnings yield.

Which is simply the inverse of PE.

Earnings Yield = 1 ÷ PE

Example:

If I can get 7.2% on a 10-year government bond with zero effort, I need to be genuinely convinced this business will grow earnings at 10–12% per year for the next five years to justify the equity risk.

That's a much harder case to make than saying:

"PE of 20 looks reasonable."

PE works reasonably well for businesses with stable, predictable, cash-generative earnings, such as:

It breaks for anything that's reinvesting aggressively, because the earnings number is suppressed by the reinvestment itself.

Amazon traded at absurd PE ratios for a decade not because the market was irrational but because reported earnings were intentionally low while the business was building infrastructure.

The PE told you almost nothing useful during that period.

I don't have a clean system for when to override the PE entirely versus when to adjust it.

I'm still working through where that line sits — particularly for Indian companies in transition periods between growth phases.

I've been watching a cluster of mid-cap consumer discretionary names in India where reported PE ratios look range-bound between 28–34x, but the earnings base underneath has quietly shifted from operating profit to a mix of operating profit and working capital gains.

The ratio looks stable.

I'm not sure the earnings quality underneath it is.

Four more quarters should tell me whether this is a composition shift or noise.

I don't trust the pattern yet.

Nishant Chandravanshi — Mr Chandravanshi writes about judgment, decision-making, investing, and systems thinking.

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