Valuation ratios turn company financials into comparable measures. P/E, PEG, P/B, P/S and P/FCF are widely used, but each is designed for a different type of business and each can be misleading without context.

P/E Ratio

The price-to-earnings ratio compares a company's share price with earnings per share. It is useful for profitable businesses, but it can become less meaningful when earnings are cyclical, unusually high or temporarily depressed.

PEG Ratio

The PEG ratio relates P/E to an estimated or historical earnings-growth rate. It attempts to put valuation into a growth context, but the result is highly sensitive to the growth assumption.

P/B Ratio

Price-to-book compares market value with accounting equity. It can be particularly useful for asset-heavy or financial businesses, although book value may not capture the economic value of intangible assets.

P/S Ratio

Price-to-sales compares market value with revenue. It can be useful for companies with low or negative profits, but sales alone say little about margins and future cash generation.

P/FCF Ratio

Price-to-free-cash-flow compares the market value with cash generated after investment. It can provide a useful alternative to earnings-based measures, particularly where accounting profits are affected by non-cash items.

Compare Like With Like

Valuation is most useful when companies have similar business models, growth profiles, margins and capital structures. Comparing a mature utility directly with a fast-growing software business using only P/E rarely produces a meaningful conclusion.

Use Multiple Measures

Investors should combine valuation ratios with growth, profitability, debt, competitive advantage and cash-flow analysis. A cheap multiple may reflect weak fundamentals or high risk rather than an overlooked opportunity.

Portfolio Context

Company valuation is only one part of the decision. Position size and portfolio concentration also matter. A seemingly attractive investment can create excessive exposure to a particular sector, country or factor.

FAQ

Which valuation ratio is best?

There is no single best ratio. The appropriate measure depends on the company's business model and financial characteristics.

Does a low P/E mean a stock is cheap?

Not necessarily. A low P/E can reflect weak expected growth, cyclical earnings, high financial risk or other concerns already recognised by the market.

Conclusion

Valuation ratios are useful tools, not standalone answers. The strongest analysis combines several measures with business fundamentals, expected growth, risk and the price being paid for the underlying cash flows.