IPO excitement can make investors forget the most basic question: is the company asking for a fair price? A strong brand, high subscription, big anchor investors and positive grey market premium may create confidence, but none of these can replace valuation. One of the simplest ways to judge IPO valuation is the Price to Earnings Ratio, commonly called the P/E ratio.
The P/E ratio tells you how much investors are paying for every ₹1 of the company’s earnings. It does not give the full answer, but it gives a clean first check. When used properly with peer comparison, profit growth and business quality, it can help retail investors avoid blindly applying for overpriced IPOs.
What Is P/E Ratio in an IPO?
P/E ratio means Price to Earnings Ratio. It compares the IPO price with the company’s earnings per share.
The formula is simple:
P/E Ratio = IPO Issue Price ÷ Earnings Per Share
For example, if a company’s IPO price is ₹300 and its EPS is ₹15, then:
P/E = 300 ÷ 15 = 20 times
This means investors are paying ₹20 for every ₹1 of annual earnings.
A low P/E may look cheap, and a high P/E may look expensive. But this is not always true. A fast-growing company may deserve a higher P/E, while a slow or risky company may not deserve even a low P/E.
Where to Find P/E Details in an IPO Prospectus
The best place to find IPO valuation data is the company’s Red Herring Prospectus or final prospectus. SEBI’s public issue filing section publishes IPO documents such as draft offer documents, red herring documents and final offer documents. These documents contain business details, financial statements, risk factors and offer-related information.
In the prospectus, look for sections such as:
- Basis for Issue Price
- Financial Information
- Restated Financial Statements
- Accounting Ratios
- Peer Comparison
- Objects of the Issue
- Risk Factors
The “Basis for Issue Price” section is especially important because it usually shows EPS, net asset value, return on net worth and peer valuation comparison.
Step 1: Find the IPO Issue Price
First, check the IPO price band. In a book-built IPO, the company and its book-running lead manager set a price band before the issue opens. SEBI’s investor education page explains that the DRHP contains issue details except the final price, while the RHP is issued before the IPO opens and contains important offer details.
For valuation, investors usually check P/E at the upper price band, because strong IPOs generally get priced at the upper end.
For example, if the price band is ₹280–₹300, calculate valuation using ₹300.
Step 2: Find the EPS
EPS means Earnings Per Share. It shows how much profit the company earns for each share.
The formula is:
EPS = Profit After Tax ÷ Number of Equity Shares
However, retail investors do not usually need to calculate EPS from scratch. Most IPO prospectuses provide EPS under accounting ratios. Check whether the EPS is basic, diluted, weighted average, or annualised.
For IPO valuation, diluted EPS is usually safer because it considers the possible impact of additional shares or convertible securities. If the company has issued bonus shares, split shares or fresh shares, read the adjusted EPS carefully.
Step 3: Calculate the P/E Ratio
Once you have the issue price and EPS, divide the issue price by EPS.
Example:
IPO price: ₹450
EPS: ₹18
P/E ratio = 450 ÷ 18 = 25 times
This means the IPO is asking investors to pay 25 times its earnings.
Now the important question is not only “Is 25 high or low?” The real question is: 25 compared to what?
Step 4: Compare with Listed Peers
P/E becomes useful only when compared with similar companies. If the IPO company is from the hospital sector, compare it with listed hospital companies. If it is an auto component company, compare it with listed auto component companies. Do not compare a banking IPO with an FMCG company.
Suppose the IPO company is asking for a P/E of 45, while listed peers are trading at 25–30. Then the IPO may be expensive unless the company has much better growth, margins, brand strength or return ratios.
But if the IPO P/E is 18 and peers are trading at 30, the IPO may look reasonably priced, provided the company’s business quality is good.
Step 5: Check Profit Growth
A company with rising profits can justify a higher P/E. A company with falling or unstable profit should not be given a premium valuation easily.
Look at profit after tax for the last three years. Ask these questions:
- Is profit growing every year?
- Is revenue also growing?
- Are margins improving?
- Is growth coming from real business or one-time income?
- Is cash flow from operations positive?
A company showing sudden profit growth just before IPO needs careful checking. Sometimes profits improve due to temporary factors, cost cuts or one-time gains. Such earnings may not continue after listing.
Step 6: Check Whether the IPO Is Fresh Issue or Offer for Sale
This matters for valuation. In a fresh issue, money comes into the company and may be used for expansion, working capital, debt repayment or business growth. In an Offer for Sale, existing shareholders sell shares and the money goes to them, not to the company.
If the IPO is mostly Offer for Sale and the valuation is expensive, investors should be more careful. A high P/E becomes easier to accept when the company is raising money for real growth and has a strong plan for using funds.
Step 7: Do Not Use P/E Alone
P/E ratio is useful, but it has limits. It does not work well for loss-making companies because there is no positive earnings base. It may also mislead in cyclical sectors where profits rise sharply during good times and fall during bad times.
For banks and NBFCs, price-to-book value may also matter. For infrastructure or manufacturing companies, debt and cash flow are important. For platform businesses, revenue growth and path to profitability may matter more.
So, P/E should be used with other checks such as debt, return on equity, cash flow, margins, promoter quality, industry outlook and risk factors.
Simple IPO P/E Decision Rule
If the IPO P/E is lower than peers and the company has stable growth, it may be reasonably valued.
If the IPO P/E is similar to peers, check whether the company’s quality is also similar.
If the IPO P/E is much higher than peers, the company must have stronger growth, better margins, better brand power or a special advantage.
If the IPO P/E is high but profit growth is weak, the IPO may be overpriced.
Final View
P/E ratio is one of the easiest tools to check IPO valuation. First find the IPO issue price, then check EPS from the prospectus, calculate P/E, and compare it with listed peers. After that, study profit growth, business quality, debt, cash flow and use of IPO funds.
The best IPO decision is not based on GMP or hype. It is based on price, earnings and business strength. A good company at a bad valuation can still become a poor investment. A smart investor always asks: am I paying a fair price for the earnings this company can realistically deliver?
