Valuation ratios are a critical part of any investor’s toolkit. They help determine whether a stock is trading at a fair price relative to its earnings, book value, sales, or growth potential. But interpreting them requires nuance—especially in different market conditions and across sectors. In this guide, we unpack the key valuation ratios, how they are used, and how they fit into a broader investment thesis.
Valuation ratios compare a company’s market value (usually price per share or market capitalization) to a fundamental metric like earnings, revenue, or book value. They are used to:
Compare similar companies
Key Valuation Ratios Explained
Formula: Price per Share / Earnings per Share (EPS)
A low P/E may indicate undervaluation—or low growth prospects.
Trailing P/E uses past 12 months; Forward P/E uses forecast earnings.
Example: A high-growth tech stock may trade at 35x earnings, while a utility may sit around 12x.
Formula: P/E Ratio / Expected EPS Growth Rate
PEG < 1.0 suggests undervaluation (growth not priced in).
Example: A company with a P/E of 20 and growth of 25% has a PEG of 0.8 — potentially attractive.
Formula: Market Price per Share / Book Value per Share
P/B < 1.0 may suggest deep value, especially in asset-heavy sectors.
More relevant for banks, insurers, and industrials.
Example: A bank with a P/B of 0.9 might be undervalued—but also could signal underlying risk.
Formula: (Market Cap + Debt - Cash) / EBITDA
Strips away capital structure differences.
A lower ratio generally means better value.
Example: EV/EBITDA of 8x is often seen as a baseline. Tech growth names may trade at 15x+, mature industrials at 7x.
Formula: Market Cap / Total Revenue
Often used in early-stage tech or biotech firms.
Example: A SaaS firm with high growth but no profit may trade at 8x sales. Compare against sector peers.
? Bull Market
PEG becomes more relevant than P/E.
? Bear Market
Defensive sectors (utilities, healthcare) favored for low P/E and stable P/B.
✨ Transition Markets
Companies with sustainable margins and moderate valuation often lead recoveries.
Common Pitfalls in Valuation Analysis
Sector mismatch: Comparing a bank’s P/E to a SaaS firm is misleading
Ignoring leverage: Market cap doesn’t account for debt; use EV-based metrics
Case Study: Two Stocks, Same P/E
P/E: 18x
PEG: 3.6
Stock B (Cloud Software)
EPS Growth: 30%
P/B: 12
Pro Tips for Smart Valuation Analysis
Always cross-reference with growth, margins, and balance sheet
Contextualize with market conditions and rate environment
Price tells you what you pay. Valuation ratios help you understand what you’re actually getting.
This article was written by Itai Levitan at www.forexlive.com. Read More Details
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