Reading a Company
Intermediate4 Min Read
P/E and the Valuation Ratios
You can't tell whether a stock is cheap or expensive by looking at its price.
A $20 stock is not cheaper than a $400 stock. Price alone says nothing; it starts saying something when set against the earnings the company produces.
Why a Ratio and Not a Price
The Main Ratios
| Ratio | Formula | When it's useful |
|---|---|---|
| P/E | Price ÷ earnings per share | Profitable, mature companies |
| Forward P/E | Price ÷ expected earnings | Growing companies |
| P/B | Market cap ÷ book value | Banks, asset-heavy businesses |
| P/S | Price ÷ sales | Companies not yet profitable |
| EV/EBITDA | Enterprise value ÷ EBITDA | Comparing indebted companies |
| PEG | P/E ÷ growth rate | Pricing the growth into the multiple |
The last row is genuinely useful: a company at a P/E of 40 growing 50% a year may not be more expensive than one at a P/E of 15 growing not at all.
What a High P/E Says
One of two things:
- The market expects this company's profits to grow fast.
- The market is too optimistic.
The ratio won't tell you which. Only time does. Valuation therefore produces not a decision but a question: what are the odds that the growth needed to justify this price actually happens?
The Rules of Comparison
A P/E on its own is meaningless. It needs three comparisons to mean anything:
- Against its own sector. A software company's P/E doesn't compare to a bank's.
- Against its own history. What band has the company traded in over five years?
- Against its own growth. Expecting the multiple to hold while growth slows is not realistic.
Accounting Profit vs. Cash
The P/E's denominator is accounting profit, and accounting profit can differ from money actually entering the till. One-off items — a legal settlement, an asset sale, a restructuring — can inflate a quarter's profit and make the P/E look artificially cheap.
That is why a serious assessment also reads cash flow. A company whose profit grows while free cash flow weakens usually gives its first warning there. More: Reading Cash Flow
Where You'll See It on This Site
The Key Metrics card on the stock page shows P/E, P/B and dividend yield together. On the Companies screen you can filter by sector and see the same sector's ratios side by side — which is the only way the comparison means anything.