Every investor, regardless of their experience or location, has encountered stocks trading at extraordinarily high price-to-earnings (PE) ratios. Some companies even surpass a PE of 100, stretching valuation logic to its limits.

Many investors have asked me whether investing in such high PE stocks is a good idea and why I personally prefer to avoid them. High PE companies are often perceived as guaranteed future winners with top-tier management, while low PE stocks are often seen as troubled companies with uncertain prospects.

A recent experience with a broker offering me shares of an unlisted fintech company from a reputable financial services conglomerate at a steep valuation made me rethink the dynamics of high PE investing. This encounter led to a comparative analysis between high PE and low PE stock investments.

This article aims to highlight the risks and challenges of investing in high PE stocks and whether they truly deliver the expected returns.

A Case Study: Investing in a High PE Stock

Recently, I was presented with an opportunity to buy shares of XYZ Digital Payments Limited at ₹1,200 per share. Since the company was unlisted, buying opportunities were scarce.

Being a value-driven investor, I conducted a preliminary analysis using the company’s financials available on its website. The results were eye-opening:

• XYZ Digital Payments had an EPS of ₹20.
• The offer price translated to a PE ratio of 60.

How a Sales Pitch Convinces Investors to Accept High PE Ratios

When companies trade at high PE multiples, they are often justified using narratives such as:

• The massive growth potential of digital payments in India.
• The company’s strong leadership and execution track record.
• The brand’s ability to attract top talent and scale rapidly.
• The company’s future IPO plans that could push valuations even higher.

Many public companies follow a similar script. Think of businesses like Avenue Supermarts (DMart), Titan, and Bajaj Finance—market leaders with strong narratives supporting their high valuations. However, the critical question remains: Do these valuations translate into superior long-term returns?

Testing the High PE Investment Assumptions

For the sake of analysis, let’s assume an investor purchased XYZ Digital Payments in 2024 at ₹1,200 per share. Fast forward to 2034:

1. The company’s earnings grow at an impressive 20% CAGR.
2. Its EPS reaches ₹123.76 after 10 years.
3. Similar established fintech companies trade at a PE ratio of 30.
4. Assuming XYZ Digital Payments follows suit, its price would be ₹3,713 (= ₹123.76 * 30).

Calculating the annualized return:

• CAGR = (3,713 / 1,200)^(1/10) – 1 = 11.9%
• Adding a 1.5% dividend yield results in a total return of 13.4% per annum.

While 13.4% is respectable, it’s far from extraordinary given the risks of investing in high PE stocks

Risks of Investing in High PE Ratio Stocks

Let’s examine the potential risks that could prevent a high-growth company like Avenue Supermarts Limited (DMart) from sustaining a 25% annual growth rate over the next decade:

• Increased Competition: Large retail chains like Reliance Retail and Amazon might aggressively expand their grocery and discount retail businesses, offering lower prices and better deals, leading to margin pressures for DMart.
• Regulatory Changes: The government could introduce stricter regulations on retail pricing, e-commerce, or foreign direct investment, potentially impacting DMart’s expansion strategy.
• Execution Risks: Leadership missteps or strategic errors could delay store openings, hinder inventory management, or affect customer satisfaction, slowing down the company’s growth trajectory.
• Consumer Behavior Shifts: More customers might shift towards online grocery shopping, reducing footfall at physical DMart stores, making it difficult to achieve projected revenue targets.
• Unexpected Economic Conditions: High inflation, reduced consumer spending, or a global economic downturn could negatively impact DMart’s revenue growth and profitability.
• Judicial/Legal Actions: Court rulings or public interest litigations against real estate acquisitions for store expansion could delay DMart’s growth plans, similar to legal cases that impacted infrastructure and telecom sectors in the past.

Market Valuation Risks

Similarly, multiple factors might impact the valuation that the market is willing to assign to DMart after 10 years:

• Stock Market Cycles: The economy might face a downturn in 2035, affecting investor sentiment and reducing valuations across sectors.
• India’s Economic Performance: Political instability or ineffective government policies over the next decade could lead to slower economic growth, affecting stock market returns.
• Change in Investment Preferences: Foreign institutional investors (FIIs) might shift their focus to emerging markets with better growth prospects, reducing capital inflows into Indian equities.
• Tax Policy Changes: The government could introduce long-term capital gains tax hikes or other measures that make stock market investments less attractive.

Given these uncertainties, it is crucial for investors to perform sensitivity analysis on different scenarios of earnings growth rates and valuation multiples to assess potential returns realistically when investing in high PE ratio stocks like DMart.

The Risks of Investing in High PE Ratio Stocks

Let’s analyze the potential outcomes of investing in a stock with a high PE ratio of 50 by conducting a sensitivity analysis (assuming a constant dividend yield of 1.3%).

The Valuation Trap

When an investor buys a stock at 50 times earnings, they are betting on consistently high growth to justify the valuation. However, even strong businesses can struggle to sustain rapid growth over a decade.

For instance, if a company like Avenue Supermarts (DMart) grows its earnings at 15% annually—a solid rate—its valuation multiple becomes a critical factor in determining the final return. If the market assigns a PE ratio of 25 in 10 years, the investor’s annual return would be around 9%.

However, if the market values DMart at a more reasonable PE ratio of 15 (assuming a PEG ratio of 1), the return would shrink to just 3%—less than a basic savings account that offers 4% (tax-free up to ₹10,000 per year and about 2.8% after the highest tax rate of 30%).

Even if DMart achieves an extraordinary growth rate of 25% per annum for a decade, but the market lowers its PE ratio to 15, the investor’s return would still be a modest 12% or lower. Worse, if earnings grow at 10% annually and the market values it at a PE of 20, the investor could face losses.

The Marathon Analogy

Investing in high PE stocks is like running on a treadmill at 20 km/h for 10 years—exhausting, demanding, and risky. The investor must hope that the market continues to reward the company with high valuations; otherwise, the effort may not be worth it. With such a thin margin for error, even a small misstep—whether due to economic downturns, industry disruptions, or shifting investor sentiment—can result in subpar returns.

This analysis underscores the importance of valuation discipline. Paying too much for growth stocks can lead to disappointing outcomes, even if the business performs well. Long-term investors are better off seeking a balance between growth potential and reasonable valuations to maximize risk-adjusted returns.

“Never overpay for a stock, no matter how promising it seems!”

Imagine an investor discovers a company that is relatively unknown but has strong growth potential, stable profitability, and a conservative financial structure—all available at an attractive valuation.

Low PE Ratio = Lower Investment Risk

Now, let’s examine how the investor’s total return (including a 1.3% dividend yield) might look under different scenarios of earnings growth over the next 10 years, assuming the stock was bought at a PE ratio of 10:

• If the company grows earnings at 10% annually and the market continues valuing it at a PE of 10, the investor would earn a total return of 11%—comparable to some of the safest fixed-income instruments in India.
• Any scenario in which the company achieves higher earnings growth or the market assigns it a higher PE multiple would yield even better returns.
• If earnings grow at 20% annually and the PE ratio expands to 20, the investor could achieve an annual return of 30%!

The Hidden Risk of Overpaying

Historically, many high PE stocks have underperformed despite strong business growth. Let’s explore a few examples:

Example 1: Info Edge (Naukri.com)

During its peak valuation in 2021, Info Edge traded at a PE ratio exceeding 100, driven by optimism about its online recruitment and investment in startups like Zomato and PolicyBazaar. However, as funding slowed and competition increased from LinkedIn and emerging HR-tech platforms, investor sentiment shifted.

Despite revenue growing from ₹1,086 crore in FY2017 to ₹2,354 crore in FY2023 and net profits increasing significantly, its PE ratio declined to nearly 40. Investors who bought at the peak valuation saw limited returns over the years.

Example 2: Avenue Supermarts (DMart)

Between 2018 and 2021, DMart commanded a PE multiple of over 150 due to its rapid store expansion and operational efficiency. However, as growth rates normalized and inflationary pressures affected margins, the stock’s PE multiple contracted below 80, despite steady profit growth.

An investor who purchased at an inflated valuation experienced stagnant returns, illustrating that even fundamentally strong businesses can struggle when stock prices exceed their intrinsic worth.

Example 3: Bajaj Finance

Bajaj Finance was once the poster child of NBFC growth, with its stock trading at a PE ratio of nearly 90 in 2019. However, as economic conditions tightened and regulatory concerns emerged, the PE ratio fell to nearly 30 by 2023.

During this period, profits continued to rise, but the stock price remained flat or declined for investors who entered at high valuations.

Key Takeaway

A great business does not always translate into great stock returns if the entry price is too high. When valuations surge beyond sustainable levels, even strong earnings growth may not prevent PE contraction. Investors should focus on buying quality businesses at reasonable prices to maximize long-term returns.

Key Takeaways

From the analysis above, investors can see that they can tilt the odds of the stock market in their favor by following a simple principle: never overpay for a stock. No matter how exciting a company’s growth story appears, buying at an excessively high PE ratio often leads to disappointing long-term returns. Instead, investors should focus on identifying businesses that demonstrate steady growth, maintain strong profitability, and operate with a conservative financial structure—yet remain underappreciated by the broader market.

The search for such hidden gems requires patience and diligence, but the rewards can be substantial. Even moderate earnings growth, combined with eventual market recognition by institutional investors or brokerage firms, can deliver impressive returns.

Successful investing starts with selecting the right stocks at the right price. Think of it as a treasure hunt—once an investor identifies a promising company at a reasonable valuation, they can hold it for years and add to their position during market downturns, knowing they are playing with favorable odds.

No wonder some of the most accomplished investors emphasize:

👉 “Never overpay for a stock.”
👉 “Well begun is half done.”

Or, as I like to put it:

“Buy great stocks cheap, and sleep in peace.”

Addressing Common Investor Concerns

Many investors assume that if a company is fundamentally strong, the market must have already recognized its potential—leaving no room for attractive valuations. While this is often true for large, well-known businesses, history shows that smaller, high-quality companies can remain unnoticed by institutional investors for extended periods. This creates unique opportunities for patient, long-term investors to accumulate shares at undervalued prices.

Conversely, some investors believe that stocks with low PE ratios are cheap for a reason—they may have underlying problems, and their low valuation might be justified. While this is sometimes the case, it is within this very segment that hidden opportunities exist. Many outstanding investments have come from companies that were initially overlooked, only to deliver exceptional returns once their potential was recognized.

The Power of a Few Good Investments

An investor does not need to find dozens of such undervalued stocks to build significant wealth. The experiences of legendary investors suggest that even a handful of well-selected companies over a lifetime can be enough to create substantial returns. If an investor can identify just one such stock every year or two, it can make all the difference.

Is a High PE Ratio Justified Solely Based on Industry Trends?

Industry PE does provide a broad understanding of a company’s relative valuation within its sector. However, it can be misleading, especially when excessive optimism surrounds an industry—creating investment bubbles.

Take the mid-2000s real estate boom as an example. Companies like DLF and Unitech were commanding sky-high PE multiples. The sector’s overall excitement made it easy for smaller, lesser-known developers to enter the stock market and get valuations that seemed attractive compared to industry leaders. Many investors assumed they were getting a bargain simply because a smaller real estate company traded at a discount to market giants.

Similarly, in the renewable energy space during the late 2010s, companies with minimal operational history managed to secure high PE ratios merely because the industry was in focus. Some companies even rebranded themselves with buzzwords like “Green Energy” or “Solar Power” in their names, causing their stock prices to surge despite weak fundamentals.

Now, consider a company with a PE of 30. Typically, a company achieving such a valuation must have strong fundamentals—take Nestlé India today, which has a PE of around 30 due to its brand strength and pricing power. However, in overheated markets, companies without any real competitive advantage often fetch high PE multiples just because they belong to a trending industry.

Ultimately, a company’s valuation should be justified by its individual financial strength, competitive position, and growth prospects rather than industry-wide PE ratios. Industry PE may provide a reference point, but relying on it as the primary valuation tool can lead to poor investment decisions.

FAQs on Investing in Thematic Businesses with High PE Ratios

1. What are thematic businesses, and why do they have high PE ratios?

Thematic businesses focus on specific trends or emerging sectors, such as renewable energy, artificial intelligence, or electric vehicles. Due to their growth potential and market excitement, investors often assign high PE (Price-to-Earnings) ratios, sometimes disregarding traditional valuation methods like Discounted Cash Flow (DCF).

2. Should I invest in a company with a PE ratio of 69.95?

A PE ratio of 69.95 suggests the stock is priced at a significant premium. Regardless of growth and profitability, such valuations offer little to no margin of safety, meaning any negative surprise can lead to sharp corrections. While some investors prefer high-PE growth investing, I personally avoid stocks with such extreme valuations.

3. What is the margin of safety, and why is it important?

The margin of safety is the difference between a stock’s intrinsic value and its market price. A higher margin of safety reduces investment risk. Stocks with extremely high PE ratios usually have a negative margin of safety, meaning they are priced for perfection, leaving no room for error.

4. Can high-PE stocks still be good investments?

Yes, but only if the company’s future earnings growth justifies its valuation. Investors have made money using various approaches—high PE growth investing, low PE value investing, technical analysis, and more. The key is to choose an investment style that aligns with your risk tolerance and conviction.

5. How should I approach investing in high-PE stocks?

• Conduct thorough due diligence beyond just PE ratios.
• Assess the company’s growth potential, competitive advantage, and industry trends.
• Compare its valuation with peers to determine if the premium is justified.
• Be prepared for volatility, as high-PE stocks can experience sharp price swings.

6. What’s your view on low PE vs. high PE investing?

Both strategies have merit. Low PE stocks often provide a margin of safety, while high PE stocks may offer explosive growth. The best approach depends on your investment philosophy, risk appetite, and time horizon.

7. Any final advice before investing?

There is no single path to success in stock market investing. Investors have succeeded using different strategies—growth investing, value investing, arbitrage, technical analysis, and more. Choose a path you are comfortable with, and always perform your own research before making investment decisions.

Would love to hear your thoughts! Share your experiences with high PE and low PE stocks in the comments.