How to Know If a Stock Is Cheap or Expensive - P/E Ratio Masterclass

Kainat Gul

May 15 • 📚 Learn

Most investors look at a stock, see the price, and think: "Rs. 50? That's cheap."

Rs. 50 compared to what?

Compared to yesterday's price? Compared to what their friend told them? Compared to a gut feeling?

This is how money gets lost. Through buying without context.

Here's the context every investor needs before touching a single stock.

P/E Ratio. Two letters that separate guessing from investing.

Let's forget stocks for a second.

You're looking to buy a small shop. A general store in your neighbourhood.

Shop A costs Rs. 10 lakh to buy. It makes Rs. 1 lakh profit every year. You'll get your money back in 10 years.

Shop B costs Rs. 50 lakh to buy. It also makes Rs. 1 lakh profit every year. You'll get your money back in 50 years.

Same profit. Completely different price.

Which one do you buy?

Obviously Shop A, unless Shop B is sitting on a main commercial road, has a loyal customer base built over 20 years, and is about to get a huge apartment complex built right next door. Then maybe Rs. 50 lakh makes sense.

That logic, price versus what you're actually getting, is exactly what P/E ratio measures.

P/E = Stock Price ÷ Earnings Per Share

If a stock is trading at Rs. 100 and the company earns Rs. 10 per share, P/E is 10.

You are paying Rs. 10 for every Rs. 1 this company makes. That's it. That's the whole concept.

Now let's make it even simpler.

Think of P/E as the number of years it takes to get your money back, assuming profits stay the same.

P/E of 10? You recover your investment in 10 years. P/E of 30? Thirty years. P/E of 5? Five years.

Suddenly that number means something real.

"Okay so low P/E = good, high P/E = bad. Simple."

Not so fast.

Here's where most beginners make the mistake.

Let's go back to shops.

Your neighbour tells you about a shop selling for Rs. 5 lakh. Makes Rs. 1 lakh profit. P/E of 5. Sounds like a steal.

But when you visit, the location is terrible, the manager just quit, and the owner is selling because a big superstore is opening right across the street next month.

Low price. Good reason.

Now another shop. Rs. 40 lakh. Earns Rs. 1 lakh right now. P/E of 40, sounds insane. But it's the only pharmacy in a rapidly growing neighbourhood, has a loyal customer base, and is about to start home delivery across the entire area.

High price. Also good reason.

This is the game. P/E alone doesn't tell you buy or sell. It tells you, start asking questions.

The 3 questions every beginner should ask about P/E:

Question 1: Compared to what sector?

A textile company with P/E 20 might be overpriced. A technology company with P/E 20 might be a bargain. Different industries grow at different speeds. Always compare apples to apples.

Think of it this way, a small neighbourhood kiryana store and a modern retail outlet don't charge the same margins. Neither should their valuations.

Question 2: Compared to its own history?

If a stock has always traded at P/E 25 and suddenly it's at P/E 10, something changed. Maybe the whole market fell. Maybe the company hit a rough patch. Maybe it's a golden opportunity.

Your job is to find out which one.

Question 3: Are earnings actually growing?

A stock with P/E 30 but earnings growing 50% per year is a completely different animal than a stock with P/E 30 and flat or falling earnings.

Imagine your shop made Rs. 1 lakh profit last year, Rs. 3 lakh this year, and is projecting Rs. 6 lakh next year because the entire street is being converted into a commercial hub. You'd happily pay more for that shop today, because tomorrow it's worth even more.

Growth changes everything.

Put it all together, here's your checklist

Next time you look at any stock on PSX, find its P/E and ask:

✅ Is it lower than the sector average?

✅ Is it lower than its own historical average?

✅ Are earnings growing, not shrinking?

If all three are yes, you haven't found a stock to buy.

You've found a stock worth researching seriously.

That distinction matters. P/E is not a buy button.

It's a torch in a dark room. It shows you where to look.

The investor who understands P/E doesn't just see a stock price. They see what they're actually paying for, and whether it's worth it.

Every great investment decision starts with that one question: am I getting value for this price?