Price to earnings

Share price divided by earnings per share. The most quoted number in equity markets and the most misused.

Take a share at ₹1,200 with earnings of ₹12.30. It trades at 97.6 times.

What the multiple actually contains is three things at once: how fast the company will grow, how good the returns on the money it reinvests are, and how certain both of those are. High multiples aren't expensive and low ones aren't cheap. Each is a statement about expectations, and your job is to decide whether the expectation is reasonable. A dominant retailer with a long runway of new stores ahead of it can hold a multiple several times the market's for years at a stretch, and what you're paying for is decades of high-return growth. Whether the growth arrives is a separate question from whether the multiple is high, and the second question is the easy one.

Its weak point is the denominator. Earnings can be depressed by a one-off charge, inflated by an asset sale, or meaningless for a company at the bottom of a cycle.

Never compare a multiple without knowing what's in the E.

Every multiple is a sentence about the future.

It's worth stating the arithmetic behind that sentence once. For a business in a steady state, the justified multiple rises with the growth rate provided the return on reinvested capital exceeds the required return, rises with that return on reinvested capital, and falls with the required return. When a business earns less than its cost of capital, faster growth lowers the justified multiple. Two of those three are properties of the business and the third is a property of the market. So a company earning 30% on capital deserves a higher multiple than one earning 12% at the same growth rate: it needs less reinvestment to grow, so more of its profit reaches the owner. If a high multiple can't be explained by growth and returns, somebody's paying for something else.