Valuation Ratios Cheat Sheet: Is the Stock Cheap or Expensive?
Earnings-Based Ratios
| Ratio | Formula | When to Use | Benchmark |
|---|---|---|---|
| P/E Ratio | Share Price / EPS | Profitable companies with stable earnings | S&P 500 avg: ~18–22x |
| Forward P/E | Share Price / Forward EPS Estimate | Growth companies; reflects expectations | Generally lower than trailing P/E |
| PEG Ratio | P/E / EPS Growth Rate (%) | Comparing growth stocks at different P/Es | ~1.0x = fairly valued |
| Earnings Yield | EPS / Share Price (inverse of P/E) | Comparing stocks to bond yields | Higher = cheaper stock |
Enterprise Value Ratios
| Ratio | Formula | When to Use | Typical Range |
|---|---|---|---|
| EV/EBITDA | EV / EBITDA | Most comparable across capital structures | 8x–15x (sector-dependent) |
| EV/EBIT | EV / EBIT | When D&A differences matter (asset-heavy) | 10x–18x |
| EV/Revenue | EV / Revenue | Unprofitable high-growth companies | 1x–10x+ |
| EV/FCF | EV / Free Cash Flow | Cash-flow-focused valuation | 15x–25x |
Asset & Income-Based Ratios
| Ratio | Formula | When to Use |
|---|---|---|
| P/B Ratio | Share Price / Book Value per Share | Banks, insurance, asset-heavy businesses. Below 1.0x = trading below liquidation value. |
| P/S Ratio | Share Price / Revenue per Share | Early-stage or unprofitable companies where earnings ratios don’t apply. |
| Dividend Yield | Annual Dividend / Share Price | Income-focused investing. Compare to Treasury yields for context. |
| FCF Yield | FCF per Share / Share Price | Cash-based alternative to earnings yield. Higher = better value. |
P/E vs. EV/EBITDA
| Feature | P/E Ratio | EV/EBITDA |
|---|---|---|
| Capital structure neutral? | No — affected by leverage | Yes — uses enterprise value |
| Accounting distortions | Affected by D&A, tax, interest | Strips out D&A, tax, and interest |
| Best for | Comparing similar companies in same sector | Cross-capital-structure comparisons, M&A |
| Handles negative earnings? | No — meaningless when EPS is negative | Better (EBITDA positive more often) |
| Preferred by | Equity investors, retail | Investment bankers, PE professionals |
Which Ratio to Use When
Profitable, stable company? Start with P/E and EV/EBITDA. High-growth but unprofitable? Use EV/Revenue and P/S. Banks and financial companies? P/B is the standard because book value is more meaningful. Income stocks? Dividend yield plus FCF yield. Comparing acquisition targets? EV/EBITDA is the M&A standard.
Key Takeaways
- No single valuation ratio is universally best — match the ratio to the situation.
- EV/EBITDA is the most capital-structure-neutral multiple for peer comparisons.
- P/E is the most popular but is distorted by leverage, taxes, and accounting choices.
- FCF yield is the cash-based reality check — if the cash isn’t there, the valuation may be misleading.
- Always compare ratios to sector peers, historical averages, and forward estimates.
Frequently Asked Questions
What is the best valuation ratio for stocks?
There’s no single “best.” For most situations, combining EV/EBITDA (for comparability) with FCF yield (for cash reality) gives you the strongest foundation. Add P/E for context and PEG for growth adjustment.
What does a P/E ratio of 25 mean?
It means investors are paying $25 for every $1 of annual earnings. Whether that’s expensive depends on context — a 25x P/E for a company growing 30% annually is reasonable (PEG ~0.8). For a no-growth utility, it’s overpriced.
Why use enterprise value instead of market cap?
Enterprise value includes debt and subtracts cash, giving a complete picture of what it would cost to acquire the entire business. Market cap only reflects the equity portion. Two companies with the same market cap but very different debt levels have very different enterprise values.
When is P/B ratio most useful?
For financial institutions (banks, insurance), REITs, and asset-heavy companies where book value is a meaningful proxy for liquidation value. For asset-light businesses (tech, software), book value is often dominated by goodwill and intangibles, making P/B less useful.
How do you spot a value trap?
A stock with a low P/E and low P/B isn’t automatically a bargain — check for declining revenue, shrinking margins, rising debt, and poor free cash flow. If the fundamentals are deteriorating, the “cheap” valuation may be the market correctly pricing in decline.