What valuation measures are

Valuation measures are ratios that help answer whether a stock is expensive or cheap relative to its fundamental value. They turn the dense numbers in financial statements into a few ratios that are easy to compare across companies.

The main measures

  • Earnings per share (EPS): net profit divided by shares outstanding. It shows how much profit each share generates, and is an input for many other measures.
  • Price-to-earnings ratio (P/E): the share price divided by earnings per share. It shows how much investors are paying for each unit of profit. A high P/E can reflect large growth expectations or expensiveness; a low P/E can reflect undervaluation or poor prospects.
  • Price-to-book ratio (P/B): the share price divided by book value per share. It compares the market price with the net asset value recorded on the books.

How to apply it

These ratios only mean something in comparison: compare a company's P/E with the industry average, with its own history, and with peers. A single number doesn't say expensive or cheap; context does. In particular, a high P/E isn't automatically bad and a low P/E isn't automatically good; you must understand why the number is where it is.

A concrete example

Two companies at the same share price of 30. Company A has a P/E of 15, company B a P/E of 30. On valuation, company A is cheaper because you pay less per unit of profit, even though both share prices are equal. But if company B grows much faster, its high P/E may reflect legitimate expectations. The number needs the story with it.

Common mistakes

  • Treating low P/E as always cheap and high P/E as always expensive, ignoring growth and industry context.
  • Comparing ratios across very different industries without adjustment.
  • Relying on a single ratio instead of viewing several measures together.
  • Forgetting that ratios rest on past data, while price reflects future expectations.

FAQ

  • Is a low P/E always an opportunity? No. Sometimes a low P/E reflects poor prospects or high risk, not a bargain. Understand why it's low.
  • What should I compare P/E against? The industry average, the company's own history, and similar peers. Comparing across a different industry easily misleads.
  • How important is EPS? It underpins many measures and reflects per-share profitability, but can also be affected by one-off factors.

Checklist

  • ☐ Am I comparing ratios with the industry and history, or looking at a single number?
  • ☐ Do I understand why the ratio is at its level?
  • ☐ Am I viewing several measures together rather than just one?