In my 15+ years analyzing equity markets across global exchanges, I’ve seen countless investors make decisions based on a single metric: the Price-to-Earnings P/E ratio. It’s the most popular valuation tool in finance—and for good reason. But I’ve also witnessed how misunderstanding this simple ratio can lead to costly mistakes.
Today, I’ll break down everything you need to know about P/E ratios, using real examples from the Pakistan Stock Exchange (PSX) to show you how professional analysts actually use this tool.
What is the P/E Ratio?
Think of the P/E ratio as answering this question: “How much am I paying for every rupee of earnings this company generates?”
The formula is deceptively simple:
P/E Ratio = Market Price per Share ÷ Earnings per Share (EPS)
A Real PSX Example
Let’s say MCB Bank is trading at Rs. 280 per share and earned Rs. 35 per share last year.
P/E Ratio = 280 ÷ 35 = 8.0x
This means investors are paying Rs. 8 for every Rs. 1 of earnings MCB Bank generates. In other words, at current earnings levels, it would take 8 years for the company to “earn back” your investment (assuming earnings remain constant).
Types of P/E Ratios: Know What You’re Looking At
1. Trailing P/E (Historical)
This uses actual earnings from the past 12 months. Most financial websites show this by default.
Example: If HBL earned Rs. 25 per share over the last four quarters and trades at Rs. 200, its trailing P/E is 8.0x.
Pros: Based on real, audited numbers Cons: Looks backward, not forward
2. Forward P/E (Future-Looking)
This uses analyst estimates for the next 12 months.
Example: Lucky Cement currently trades at Rs. 650. Analysts expect it to earn Rs. 80 per share next year.
Forward P/E = 650 ÷ 80 = 8.1x
Pros: Forward-looking, captures expected growth Cons: Based on estimates that may prove wrong
3. Shiller P/E (CAPE Ratio)
Uses average earnings over 10 years, adjusted for inflation. Rarely used for individual PSX stocks but important for overall market valuation.
What Makes a P/E “High” or “Low”?
Here’s where experience matters. A P/E of 15x might be expensive for one company and cheap for another. Context is everything.
PSX Sector Comparison (Approximate Historical Averages)
Banks: 4-7x (HBL, MCB, UBL)
- Why low? Mature industry, regulatory constraints, economic sensitivity
Cement: 3-6x (Lucky Cement, DG Khan Cement, Fauji Cement)
- Why low? Cyclical, capital-intensive, dependent on construction activity
Oil & Gas (E&P): 2-5x (OGDC, PPL, Mari Gas)
- Why low? Commodity price volatility, government pricing controls
Fast-Moving Consumer Goods (FMCG): 12-20x (Engro Foods, Colgate-Palmolive)
- Why high? Stable earnings, brand power, consistent demand
Technology/Telecom: 8-15x (Systems Limited, PTCL)
- Why varied? Depends on growth trajectory and market position
Fertilizers: 4-8x (Fauji Fertilizer, Engro Fertilizers)
- Why moderate? Government subsidies, seasonal demand, gas allocation issues
The Four Questions I Ask Before Using P/E
Question 1: What’s the Quality of Earnings?
Not all earnings are created equal. During the 2020-2022 period, many PSX companies reported “other income” from treasury bills and PIBs that inflated earnings. This isn’t sustainable.
Real Example: A textile company might show Rs. 10 EPS, but Rs. 4 comes from one-time export rebates. The true operational EPS is Rs. 6, making the P/E much higher than it appears.
Question 2: What’s the Growth Rate?
This is where the PEG Ratio comes in:
PEG Ratio = P/E Ratio ÷ Expected Annual EPS Growth Rate
Example:
- Company A (Mature Bank): P/E of 6x, expected 5% growth → PEG = 1.2
- Company B (Tech Company): P/E of 15x, expected 25% growth → PEG = 0.6
Company B is actually cheaper relative to its growth, despite the higher P/E.
A PEG below 1.0 often suggests undervaluation relative to growth prospects.
Question 3: What’s the Industry Cycle?
Cement Example: In 2020-2021, when construction boomed post-COVID, cement companies saw P/E ratios expand to 8-10x. By 2023, as demand cooled, P/Es compressed to 3-4x. The companies didn’t change—the cycle did.
Oil & Gas Example: When crude prices surge, E&P companies like OGDC see earnings spike, which temporarily depresses their P/E ratios. But smart analysts know these commodity windfalls often reverse.
Question 4: What About Debt?
P/E ignores the balance sheet. Two companies with identical P/E ratios can have vastly different risk profiles.
Scenario:
- Company X: P/E of 5x, Debt-to-Equity of 30%
- Company Y: P/E of 5x, Debt-to-Equity of 200%
Company Y’s earnings are leveraged and riskier. Many PSX companies took on significant debt during high-interest periods (2022-2024), making their P/E ratios misleadingly attractive.
When P/E Ratios Can Mislead You
1. Cyclical Companies at Peak Earnings
Trap: A steel company might have a P/E of 3x during a boom. Looks cheap! But if earnings fall 70% next year (common in cyclicals), you’re actually paying a P/E of 10x based on normalized earnings.
2. Companies with Negative Earnings
P/E becomes meaningless. A loss-making PSX tech startup can’t be valued on P/E.
3. Companies with Inconsistent Earnings
Example: A company earns Rs. 2, Rs. 15, Rs. 3, Rs. 10 over four years. The P/E swings wildly and tells you little about true value.
4. Different Accounting Standards
Some PSX companies capitalize costs differently, use different depreciation schedules, or have varying tax treatments. Always dig into the notes of financial statements.
Practical Application: My Three-Step P/E Analysis
Step 1: Compare to History
Pull up the company’s P/E over the last 5-10 years. Is it trading at a historical premium or discount?
Example: If HBL historically trades at 5-7x P/E and is currently at 4x, it might be undervalued—assuming nothing fundamental has changed.
Step 2: Compare to Peers
How does it stack up against direct competitors?
Banking Sector Example:
- MCB Bank: 6.5x
- HBL: 5.0x
- UBL: 5.5x
- Meezan Bank: 7.0x
Why is Meezan at a premium? Perhaps stronger asset quality, better growth, or the Islamic banking premium.
Step 3: Adjust for Growth and Risk
Use supplementary metrics:
- ROE (Return on Equity): High ROE companies deserve higher P/E
- Debt levels: Lower debt = lower risk = can support higher P/E
- Earnings growth: Faster growth = justifies higher P/E
- Dividend yield: Sometimes a low P/E with a high dividend is the real bargain
The PSX Context: Why Pakistani P/E Ratios Are Low
If you compare PSX to global markets, you’ll notice Pakistani stocks trade at much lower P/E multiples:
- PSX Average: 4-6x
- S&P 500 Average: 18-22x
- Indian NSE Average: 20-25x
Why?
- Higher Risk Premium: Political uncertainty, currency volatility, and economic instability
- Liquidity Constraints: Harder to exit positions in PSX
- Corporate Governance Concerns: Weaker minority shareholder protections
- Limited Foreign Access: Most international investors avoid Pakistan or face restrictions
- Economic Challenges: High inflation, fiscal deficits, and policy unpredictability
This doesn’t mean PSX stocks are cheap—they’re appropriately discounted for higher risk.
Red Flags I Watch For
- P/E suddenly drops due to earnings spike: Often temporary, mean reversion likely
- P/E is far below peers with no obvious reason: Hidden problems?
- Company buying back shares aggressively: Reduces share count, artificially lowers P/E
- Earnings driven by non-operating items: Not sustainable
- Very low P/E in a growing company: Market might know something you don’t
Case Study: Tale of Two PSX Companies
Company A: Large Bank (2023)
- Trading Price: Rs. 220
- EPS: Rs. 40
- P/E Ratio: 5.5x
- ROE: 18%
- Dividend Yield: 7%
- Debt-to-Equity: 45% (banking industry norm)
Analysis: Solid fundamentals, trading at sector average. Fair value.
Company B: Pharmaceutical Company (2023)
- Trading Price: Rs. 180
- EPS: Rs. 60
- P/E Ratio: 3.0x
- ROE: 8%
- Dividend Yield: 2%
- Debt-to-Equity: 120%
Analysis: Low P/E is a red flag, not a bargain. Weak returns, high debt, pricing pressure from government drug controls. Market is rightfully skeptical.
Beyond P/E: Metrics I Use in Combination
Professional analysts never use P/E in isolation. My typical toolkit:
- EV/EBITDA: Better for comparing companies with different capital structures
- Price-to-Book (P/B): Essential for banks and asset-heavy companies
- Dividend Discount Model (DDM): For stable, dividend-paying companies
- Discounted Cash Flow (DCF): The gold standard for intrinsic value
- Price-to-Sales (P/S): Useful when earnings are volatile
Final Thoughts: The Wisdom in Simplicity
After analyzing thousands of companies across dozens of markets, I’ve learned that the P/E ratio’s real value isn’t in providing answers—it’s in asking the right questions:
- Why is this P/E different from peers?
- What assumptions are embedded in this valuation?
- When has this P/E been this low/high historically?
- How sustainable are these earnings?
In the Pakistani market, where information can be scarce and market efficiency questionable, combining P/E analysis with ground-level understanding of company operations, management quality, and industry dynamics separates the professionals from the amateurs.
The P/E ratio is a powerful starting point—but it’s just that: a starting point. The real skill lies in knowing what to do with the number once you’ve calculated it.
Action Items for PSX Investors
- Track P/E bands: Maintain a spreadsheet of your watchlist companies showing their 3-year P/E ranges
- Understand sector norms: Know what’s normal for cement vs. tech vs. banking
- Read beyond the headline: Always review the quarterly reports to understand earnings quality
- Use relative valuation: Don’t just ask “Is the P/E low?”—ask “Is it low compared to what?”
- Stay humble: Remember that a low P/E can stay low (or go lower) for years if fundamentals deteriorate
The stock market is the only place where things go on sale and people run away. Sometimes a low P/E is a bargain. Sometimes it’s a warning. Your job as an investor is to know the difference.
Disclaimer: This article is for educational purposes only and does not constitute investment advice. All examples are illustrative and may not reflect current market conditions. Always conduct your own research or consult with a qualified financial advisor before making investment decisions.