Introduction
Most retail investors use the P/E ratio as their first filter when evaluating a stock.
The moment they see a P/E of 100 or 150 on a tech company, they move on. They assume the stock is overpriced and not worth their time.
I also did the same thing for a long time. A few years back, I used to dislike companies like PayTM, Zomato, Swiggy, etc for their low reported profits and high P/E ratio.
| SL | Company Name | Revenue (Rs.Cr) | PAT (Rs. Cr) | P/E |
| 1 | Zomato / Eternal | 17292 | 174 | 568.11 |
| 2 | Paytm | 8437 | 552 | 63.61 |
| 3 | PB Fintech | 6794 | 671 | 98.13 |
| 4 | Nykaa | 11,350 | 150 | 486.17 |
| 5 | Swiggy | 23053 | -4,154 | (-)ve |
The problem is not that the P/E ratio is a bad metric. It is a very useful metric, but only in the right context.
When you apply it to high-growth tech companies without understanding its limitations, it gives you a misleading picture.
And that misleading picture causes you to reject some genuinely good businesses.
In this post, I’ll discuss the following:
- Why the P/E ratio fails for tech stocks,
- What causes that failure, and
- What you should be looking at instead.
This is something, I think, every retail investor should understand before making decisions about new-age companies.
What is the P/E Ratio?
The P/E ratio is simply the relationship between what you pay for a stock and what the company actually earns.
The formula for the P/E ratio is also straightforward.
PE = Share Price / EPS or = Market Cap / Net Profit
Another way to calculate the same metric is to divide the company’s full market capitalisation by its total net profit.
So if a company has a market cap of Rs. 5,00,000 crores and a net profit of Rs/ 25,000 crores, the P/E ratio will be 20.
Now, what does this number of 20 actually tell you?
There are two ways to interpret it.
- The first and more commonly known interpretation is a simple one. The lower the P/E, the cheaper the stock, and the higher the P/E, the more expensive it is.
- The second interpretation, I think, is more useful. Suppose a company earns Rs. 1 profit per year. If the P/E ratio of this company is 20. That means we’ll have to pay Rs. 20 today to buy this company. At that rate, it will take us 20 years to recover our original investment. So the P/E ratio is essentially our implied payback period (assuming profits stay constant).
This is a very practical way of understanding what it means by a P/E ratio.
But the caveat with this interpretation of the P/E ratio is that it works well when you are looking at a stable, established business whose profits are consistent and predictable. It cannot tell enough for companies whose profit (EPS) is growing at a very fast pace.
The Core Problem with the P/E Ratio
The P/E ratio has one very important assumption built into it.
For all companies, the goal is to earn as much profit as possible right now. The profit it reports today is a genuine reflection of how the business is doing.
For a traditional company like Tata Motors or HDFC Bank, this assumption aligns with the goal of the business.
These businesses work to maximize their profit. Their management is focused on increasing revenue and margins year after year.
Profit = Revenue x Margin
As the revenue grows and/or the margin improves, their profits automatically go up.
But a high-growth tech company operates on a completely different philosophy.
Today, their goal is not to maximise profit.
Instead, its goal is to capture as much market share as possible, and as fast as possible, before a competitor does.
Every rupee it earns, it immediately puts back into the business. The free money is immediately deployed to hire top engineers, to build technology infrastructure, to do aggressive marketing, and to launch new products.
This is not a failure to be profitable. It is a deliberate management decision.
When you look at the profit and loss account of a company like Zomato or Swiggy, you will see years where either the profit is tiny compared to the revenue, or the company is in outright losses.
| Op. Revenue(Rs. Cr.) | Mar ’22 | Mar ’23 | Mar ’24 | Mar ’25 | Mar ’26 |
| – Swiggy | 6,119.78 | 8,714.45 | 11,634.35 | 15,622.93 | 23,561 |
| – Eternal (Zomato) | 4,192.4 | 7,079.4 | 12,114 | 20,243 | 54,364 |
| Net Profit (Rs. Cr.) | Mar ’22 | Mar ’23 | Mar ’24 | Mar ’25 | Mar ’26 |
| – Swiggy | -3,627 | -4,179 | -2,343 | -3,114 | -4,150 |
| – Eternal (Zomato) | -1,518 | -1,014 | 291 | 697 | 615 |
| Net Margin (Rs. Cr.) | Mar ’22 | Mar ’23 | Mar ’24 | Mar ’25 | Mar ’26 |
| – Swiggy | N/A | N/A | N/A | N/A | N/A |
| – Eternal (Zomato) | N/A | N/A | 2.40% | 3.44% | 1.13% |
| Current P/E | – | – | – | – | May’26 |
| – Swiggy | – | – | – | – | N/A |
| – Eternal (Zomato) | – | – | – | – | 628 |
When you see such numbers, it is natural reaction is to think something is wrong with the business.
But actually, nothing is wrong; the business is following the course it has been set on, the growth path.
Between Mar’22 and Mar’26 (4-Year Period), the revenue of the company has grown at 40.1% p.a. for Swiggy and 89.8% for Zomato.
| Company | Mar’22 | Mar’26 | Growth Rate |
| Swiggy | 6,119.78 | 23,561 | 40.1% p.a. |
| Zomato (Eternal) | 4,192.4 | 54,364 | 89.8% p.a. |
The company is simply choosing to prioritise growth over reported profit right now.
They are spending whatever they earn (and sometimes more) to win the market before the competition does.
Because the P/E ratio depends entirely on reported profit, and because these companies are deliberately keeping profits low, the P/E either becomes incalculable (when there are losses) or inflates to absurd levels like 200 or 300.
At that point, the P/E ratio cannot tell us anything useful about whether the stock is actually cheap or expensive.
The Amazon Story Says It Better Than Any Theory
If you want to understand why a high P/E on a tech stock can be completely irrelevant, look at Amazon.
Amazon started operations around 1995. For nearly twenty years, right up to around 2015, Amazon’s reported profit was almost zero.
For two full decades, the company barely showed any earnings.
As a result, its P/E ratio was always inflated or technically incalculable.
During all those years, analysts who were trained on traditional valuation models kept writing Amazon off. Their reasoning was simple: no profit, insane P/E, stay away.
But what was Amazon actually doing during those twenty years?
- It was building AWS, which today is the engine that powers the profits of the entire Amazon business.
- It was building a logistics network so efficient that it could promise two-day, same-day, and next-day delivery at scale.
- It was creating Amazon Prime to build a loyal subscriber base that would become extraordinarily difficult to take away from them.
- And it was expanding from one country to many.
Every dollar that Amazon earned, it reinvested with a clear purpose. Not because it was struggling. But because it understood that the real prize was not this year’s profit. The real prize was to capture the market like a monopoly business.
After 2015, when all those investments started paying off together, Amazon’s profits exploded.
The P/E ratio that had looked ridiculous for years suddenly started looking very reasonable as earnings surged. On this day, the P/E ratio of Amazon is at ~31 levels.
Investors who had rejected Amazon purely on P/E grounds had missed one of the greatest wealth-creation stories in the history of the stock market.
This concept of delaying profit for growth is called “Deferred Profitability.”
There Is Also an Accounting Problem That Makes Things Worse
Beyond the deliberate choice not to show profits, there is a second reason why tech company earnings look worse than they actually are.
And this reason is related to the set accounting rules.
Consider a steel company that decides to spend Rs. 1,000 crores on building a new rolling mill.
The expected life of that mill is 20 years. Accounting rules allow this company to spread that Rs. 1,000 crore expense over those 20 years through a process called depreciation.
So in each of those 20 years, the company only shows Rs. 50 crores as an expense on its books. Even though the entire Rs. 1,000 crores went out on day one; this expense can be adjusted gradually for the next 20 years.
Now consider a tech company that spends the same Rs. 1,000 crores.
But this time, the company is spending it on R&D and hiring engineers.
Because this expense is not on our typical CAPEX category items, the same depreciation accounting rules does not apply here. Hence, the entire Rs. 1,000 crores has to be shown as an expense in the very year it is spent.
The result is a dramatic drop in reported profit in that one year. It does not mean that the business is struggling, but because of the fact that accounting rules are simply not designed for this type of expense done by the tech company.
- The steel company shows Rs. 50 crores of expense this year.
- The tech company shows Rs. 1,000 crores.
Both spent the same amount. But their reported earnings look completely different — and so do their P/E ratios.
Stock-Based Compensation Adds to the Problem
There is one more factor that pulls down the reported earnings of tech companies, and that is Stock-Based Compensation.
Tech companies frequently attract top talent by offering part of the compensation as stock options rather than full cash salary.
Suppose there is an engineer who asks for a Rs. 50 lakh package. The company might offer Rs. 30 lakhs in cash and Rs. 20 lakhs in stock options.
- From the company’s side, only Rs. 30 lakhs actually left the bank account.
- But accounting rules require the company to record the full Rs. 50 lakh compensation as an expense in its books.
- So you have a situation where the company’s actual cash outflow is Rs. 30 lakhs, but its reported expense is Rs. 50 lakhs.
That extra Rs. 20 lakhs of expense further reduces the reported profit and makes the P/E ratio look even more inflated.
So, What Should You Use Instead?
If the P/E ratio is not reliable for high-growth tech companies, the question becomes, what is?
There are three metrics that give you a far more honest picture.
(1) Price to Free Cash Flow (P/FCF)
Free Cash Flow is the actual cash that a business generates after paying for everything it needs to keep running.
It is not the accounting profit; it is the real money that comes in from customers and stays in the company after operational expenses are paid.
The reason this is an important number is that accounting profit can be distorted by the factors we just discussed, R&D expensing, depreciation methods, stock based compensation.
But cash is cash.
If customers are paying and this cash is getting accumulated in the bank account, that shows up in free cash flow regardless of how accounting rules classify your expenses.
Take Zomato as an example.
In certain periods, the company showed a negative net profit. But it was still generating significant cash from operations. Why? Because customers pay upfront on the app.
So while the P/E ratio was useless, the Price to Free Cash Flow ratio was giving investors a much more honest picture of what they were actually buying.
For growth-stage tech companies that are generating cash but reinvesting heavily, P/FCF is a far better starting point than P/E.
(2) EV/Revenue Ratio
For very early-stage companies that are not yet profitable and do not even have positive free cash flow, you need a different tool. EV to Revenue ratio is that tool.
Enterprise Value is the total cost of buying the entire business.
In terms of the formula, it looks like this:
EV = Market capitalisation + Debt – Cash.
Dividing this by annual revenue tells you how many times the market is valuing the company.
A ratio of 10x revenue sounds very expensive at first glance. But this number means nothing on its own. It has to be read alongside the company’s revenue growth rate.
- If a company is growing revenue at 70% per year and has a visible path to profitability, a 10x multiple can be completely justified.
- But if another company is showing the same 10x multiple and growing at only 10% per year with no clear profitability roadmap, it is genuinely expensive.
So you can see, the same 10x multiple, but the story changes as soon as we bring the growth factor into consideration.
This ratio of EV to Revenue forces us to think about growth. That is exactly what matters for early-stage tech businesses.
(3) PEG Ratio
The PEG ratio is interesting because it does not replace the P/E ratio; it fixes it.
The formula for PEG is simply:
PEG = PE / EPS Growth Rate.
Here is why this one small addition changes everything.
Suppose there is a company with a P/E of 60. It sounds alarming, right?
But if that company is growing its EPS at 60% per year, the PEG is 1.0. When PEG is 1 (or below), we can call such a company’s valuation perfectly aligned with its growth rate. Below the value of 1, the company is actually undervalued.
Now compare that to a company with a P/E of 20.
The PE of 20 sounds much more comfortable. But if that company is only growing earnings at 8% per year, the PEG works out to 2.5.
PEG above 2 makes a stock trade in the overvalued zone.
So you can see, the P/E alone told you the second company was cheaper. The PEG reveals the opposite truth.
Let’s Keep in Mind
Based on everything we have covered, here is how I think about which metric to use depending on the type of company:
- For a very early-stage tech company that is still loss-making and burning cash.
- We can use EV / Revenue ratio.
- But we must always pair it with the revenue growth rate.
- For such companies, we can avoid P/E entirely.
- For a growth-stage tech company that is generating cash but is also reinvesting heavily.
- We can use P / FCF ratio.
- We can also use the PEG ratio here, but only when the EPS growth has also started to show up.
- The use of P/E will still mislead us at this stage.
- For a mature company that is consistently profitable and no longer in hyper-growth mode.
- P/E becomes useful again.
- PEG is even better because it still accounts for whatever growth is left.
Conclusion
When you see a high P/E on a tech stock, do not treat it as an automatic red flag.
Stop and ask one question first: Why are the earnings low?
- Is it because the business is fundamentally weak and struggling to generate revenue?
- Or is it because management is making a deliberate, disciplined decision to reinvest aggressively today so that the company can build a dominant position tomorrow?
Those are two completely different situations.
But the P/E ratio treats them identically.
The P/E ratio is not a bad metric. It is just a metric being used in the wrong context.
Have a happy investing.
