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Summary: Lehman Brothers was trading at three times earnings when it filed for the largest bankruptcy in American history. Pets.com was worth more than some of America's oldest retailers eight months before it ceased to exist. Cheap and expensive mean nothing without the one question most investors forget to ask.
In March 2000, Pets.com was worth more than some of America's oldest retailers. It had never turned a profit. Investors called it visionary. By any measure, it was expensive. Eight months later, the stock collapsed to a few cents and the company was gone. Across the Nasdaq, some technology stocks trading at extreme earnings multiples, companies with no profits and sometimes no revenue, collapsed in the same way. The visionaries lost everything.
In 2008, Lehman Brothers was trading at roughly just three times earnings. One of the oldest investment banks in America. A name that had survived the Great Depression, two world wars and a dozen recessions. Investors called it a bargain. In September 2008, it filed for the largest bankruptcy in American history. Bear Stearns, Washington Mutual and Wachovia followed in different ways. The bargains destroyed wealth just as completely as the bubbles had.
Context tells you everything
Say you are looking to buy a new house. The first is a three-bedroom in a small town. Asking price: Rs 40 lakh. The second is an identical three-bedroom, same size, same construction. Asking price: Rs 1 crore.
The first house is in a town with no employment, a declining population and no infrastructure development planned for the next decade. The second is in a city corridor where a metro station opens next year, surrounded by new offices and schools.
Now, which one is expensive?
Price is what you pay. Value is what you get in return. Valuation is the relationship between the two. And that relationship only makes sense when you account for what the future is likely to bring. Not only could the rental yield be higher in the latter, but the future property value could also be higher.
What valuation actually means
Valuation is not a formula. It is a question: What am I paying today, relative to what I expect this to deliver in the future?
A stock trading at 50 times earnings sounds expensive. But if the company is growing earnings at 40 per cent a year, operates in a market still largely untapped and has a management team with a demonstrated history of execution, then 50 times earnings might be entirely reasonable. You are not paying for today. You are paying for what it will be in future.
A stock trading at 8 times earnings sounds cheap. But if the business is shrinking, carrying significant debt, operating in a sector being disrupted and has repeatedly failed to meet its own guidance, then 8 times earnings is not cheap. It is a low price on something that may be worth even less in the future.
Low P/E is not low risk. High P/E is not high risk. The number alone tells you almost nothing.
Markets price expectations, not history. A company is not valued on what it earned last year. It is valued based on what the market believes it will earn over the next several years. Which is why a profitable but stagnant business trades cheaply while a loss-making but rapidly growing one trades at a premium. The market is not confused. It is looking forward while most investors are looking back.
The behavioural mistakes that follow
Most valuation errors are not mathematical. They are behavioural.
Chasing cheap. An investor sees a stock down 60 per cent and assumes it must be undervalued. But a stock that has fallen 60 per cent may have fallen for very good reasons. The price dropped because expectations dropped. Buying it because it looks cheap is anchoring to a past price that may never be relevant again.
Avoiding quality. A stock that has compounded at 25 per cent annually for a decade will always look expensive relative to its history. Investors who waited for it to become cheap either never bought it or sold it too early. Quality businesses rarely go on sale. Waiting for them to is often just a sophisticated way of missing them entirely.
Overreacting to high multiples. A business growing earnings at 35 per cent a year consistently deserves a higher multiple than one growing at 8 per cent. The multiple is high because the quality is high. Selling a compounding business because its P/E looks elevated is one of the most common and most costly mistakes in equity investing.
The market is not always right about valuation. But it is usually pricing something real. Before concluding the market is wrong, it is worth understanding what it might know that you don’t.
This is precisely where most investors get stuck. Not for lack of information, but for lack of a framework to weigh it. Value Research Stock Advisor studies businesses the way this piece describes: not the P/E in isolation, but the earnings trajectory, the competitive position, the management track record and whether the current price reflects all of that or none of it. Fewer stocks, studied properly, with a clear view on when to buy, hold and sell.
The only question worth asking
Valuation is not about finding the lowest number. It is about deciding whether the future justifies the present price.
That second house—Rs 1 crore, metro station opening next year, surrounded by new offices and schools—is not expensive. It is priced for what it is about to become. The first house at Rs 40 lakh is not cheap. It is priced for a future that looks increasingly unlikely.
In investing, the question is never simply: Is this stock expensive? The real question is: Expensive compared to what? Compared to its own history? Compared to peers? Compared to what it is likely to earn three years from now?
Before you next decide a stock looks cheap or expensive, ask three things: What is the business likely to earn in three years? Is that already priced in? And what would have to go wrong for the current price to be a mistake? The answers matter far more than the P/E ratio.
Also read: What if the market gives you nothing for 10 years?
This article was originally published on May 10, 2026.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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