A company you have followed for years reports its annual results. Revenue is up 11%, profit up 8%, cash conversion is fine, there is no accounting question, no promoter issue and no debt problem. Over the following six months the share falls 40%. Somebody will explain this as an irrational market, and it is not. The business delivered 8%. What the price had been assuming was 25%, for a long time, and the moment the market stopped believing the second number the price had to do two things at once: reflect the profits that arrived, and reflect a completely different view of the profits still to come.
Shops on a lane change hands at a price expressed in years of rent. When a metro station was announced two lanes away, shops there began fetching twenty years of rent, because everybody expected the rent itself to rise once the station opened. Three years later the alignment was revised and the station went elsewhere. The rent had not fallen at all. The shops now fetch twelve years of rent, and every owner who bought at twenty has lost 40% on an asset whose income is exactly what it was.
The multiple is the number of years. It is not a mood and it is not a mistake — it is a compressed statement about how much the rent is expected to grow and for how long. When that expectation changes, the price moves even though this year’s rent did not.
The arithmetic, which is the whole lesson
- Earnings per share
- What the business actually delivered this year
- Multiple
- What the market will pay for a rupee of those earnings, which is a statement about future earnings
Example: Because it is a product rather than a sum, the two move together and multiply. A 12% rise in earnings alongside a halving of the multiple is not a 38% fall — it is 1.12 × 0.50, which is a 44% fall. This is the single arithmetic fact behind almost every case of a good business producing an appalling shareholder return.
What a high multiple is actually a statement about
A multiple compresses two separate beliefs into one number, and they behave very differently. The first is the rate — how fast profits grow next year. The second is growth durability — how many years the market believes the above-ordinary rate will persist before the business settles into something normal. Of the two, durability carries more of the value in a high multiple, because value from distant years is where the extra multiple lives at all. That is why a company can beat next year’s estimate and still de-rate: the beat addresses the rate, and something in the disclosure has changed the market’s view of the duration.
| Stage of the business | What the multiple is paying for | What ends it |
|---|---|---|
| A market being populated | A long runway of first-time customers, at high incremental returns | Penetration. The runway shortens every year whether or not anyone says so |
| Share being taken inside a large market | The gap between current share and what a strong operator can hold | The share stabilising, or a competitor responding in a way that makes further gains expensive |
| Pricing and mix improving | Margin expansion on a roughly stable volume base | The premium mix reaching the customers who can afford it |
| A steady business returning cash | The cash itself, discounted — this is the ordinary case, and it is where multiples settle | Nothing. This is the resting state, and the multiple here is a reasonable one to underwrite |
PEG, and what it does not capture
The PEG ratio divides the price-to-earnings multiple by the expected growth rate, as a rough way of asking whether the multiple is proportionate to the growth being bought. It is a useful sanity check and a poor decision rule, and the reasons are worth being precise about, because it is quoted far more confidently than it deserves.
- It treats growth as a single number when duration is what matters. Two companies growing 20% are worth very different multiples if one can sustain it for three years and the other for ten, and PEG cannot tell them apart.
- It ignores the capital required. A company that grows 20% by reinvesting every rupee it earns is not equivalent to one that grows 20% while paying out half its profits, even though PEG scores them identically. Growth that consumes capital is worth less than growth that does not.
- The growth number is somebody’s estimate. Usually a consensus forecast for one or two years, which is precisely the horizon on which forecasts are most anchored to what has just happened.
- It has no anchor at low growth. As expected growth falls towards zero the ratio explodes, which makes it meaningless exactly where the interesting judgements about mature businesses have to be made.
- It says nothing about risk. Two businesses with the same growth and the same multiple, one with heavy debt and one without, are not the same investment, and PEG scores them the same.
Work out a PEG — and then change only the growth estimate by a few points, to see how much of the answer is resting on a forecast.
A quality business, half the multiple
A company with an unblemished record has de-rated from 55 times earnings to 28 times over eighteen months. Nothing has been restated. Revenue growth has settled from the mid-twenties to about 11%, and margins are unchanged. You have followed it for years and never owned it because it always looked expensive.
A company’s earnings per share rises 12% during a year in which its price-to-earnings multiple falls from 50 to 25. What happened to the share price?
Do gali door metro ka elaan hua — wahan ki dukaanein 20 saal ke kiraye pe bikne lagin. Teen saal baad route badal gaya; ab wahi dukaan 12 saal ke kiraye pe milti hai. Kiraya ek rupya kam nahi hua, phir bhi 20 pe kharidne wale ka 40% gaya. Share ka bhaav = kamai × multiple, aur dono aapas mein guna hote hain. Kamai 12% badhi aur multiple aadha ho gaya toh bhaav 44% girta hai — bina kisi galti ke.
- Price is earnings multiplied by a multiple, so a de-rating and earnings growth compound rather than offset.
- A high multiple is mostly a statement about how long above-ordinary growth will last, not about next year’s rate.
- That is why a small slowdown at a very high multiple moves the price more than a large one at a low multiple.
- PEG ignores duration, the capital growth consumes, and risk — treat it as a sanity check, never a rule.
- After a de-rating, ask what growth the new price implies, not how far the multiple has fallen.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- de-rating meaning in stock market
- A de-rating is a fall in the multiple the market is willing to pay for each rupee of a company’s earnings, usually because its view of future growth has changed. Since price is earnings per share multiplied by the multiple, a de-rating can drive a share down sharply in a year when profits actually rose and nothing was restated. A re-rating is the same movement in the opposite direction.
- why did the share price fall when the company’s profit went up
- Because price is earnings multiplied by a multiple, and the two move together rather than adding up. Earnings rising 12% alongside a halving of the multiple gives 1.12 × 0.50 — a 44% fall in a year when the business did nothing wrong. The multiple is a compressed statement about profits still to come, so a change in what the market expects moves the price even when this year’s numbers are fine.
- the PEG ratio is calculated as
- The price-to-earnings multiple divided by the expected earnings growth rate. It is a reasonable sanity check and a poor decision rule: it treats growth as a single number when duration is what carries value in a high multiple, ignores how much capital the growth consumes, depends on somebody’s forecast for one or two years, and becomes meaningless as expected growth falls towards zero.
- what is implied growth in a share price
- Implied growth is the growth rate the current price already requires the company to deliver, worked out by running a valuation backwards from the price rather than forwards from a forecast. It converts an argument about whether a stock is expensive into a checkable question — has this business ever grown at that rate, has the industry, and for how long has anybody sustained it. That reverse-DCF habit is a more honest use of the instinct behind PEG.
- why do high PE stocks fall more on small bad news
- Because at a very high multiple a large part of the price is compensation for profits that are many years away, so any evidence about how long the above-ordinary growth will last revalues all of those distant years at once. At twelve times earnings comparatively little of the price depends on year seven, and the same news moves it far less. The sensitivity is a property of the multiple paid, not of the news.