Understanding PE Ratio, PB Ratio, and Other Valuation Metrics

PE Ratio Explained

PE = Current Market Price / Earnings Per Share. A PE of 15 means the market values the company at 15 times its annual earnings. Lower PE suggests cheaper valuation; higher PE suggests growth expectations or overvaluation.

Types of PE

Trailing PE: Based on last 12 months actual earnings. Forward PE: Based on projected future earnings. Forward PE is more useful but depends on estimate accuracy.

Sector Norms

IT companies: PE 20-35 (growth premium). Banking: PE 10-20. FMCG: PE 30-50. Infrastructure: PE 8-15. Always compare PE within the same sector, not across sectors.

PB Ratio

PB = Market Price / Book Value per Share. Measures price relative to company’s net assets. PB below 1 suggests stock trades below asset value. Banking sector heavily uses PB ratio since assets are primarily financial.

When PB Matters

Asset-heavy industries: banking, real estate, manufacturing. Less useful for IT, pharma where intellectual property drives value. Low PB + high ROE = potential value opportunity.

EV/EBITDA

Enterprise Value / EBITDA eliminates capital structure and tax implications differences. Better for comparing companies with different debt levels. EV = Market Cap + Debt – Cash. Lower EV/EBITDA suggests cheaper valuation.

PEG Ratio

PEG = PE / Earnings Growth Rate. Accounts for growth rate differences. PEG below 1 suggests undervaluation relative to growth. A company with PE 30 but 30% growth has PEG of 1 (fair value).

Dividend Yield

Annual Dividend / Stock Price. Higher yield suggests income potential. Very high yield may signal price decline or unsustainable payouts. Compare with sector average and historical levels.

When Valuations Mislead

Cyclical companies have low PE at cycle peaks (high earnings). Loss-making companies have no PE. One-time gains inflate earnings temporarily. Compare 3-5 year average metrics for better assessment.

Practical Application

Step 1: Screen stocks with PE below sector median. Step 2: Check PB and ROE for asset efficiency. Step 3: Use PEG to account for growth. Step 4: Compare EV/EBITDA across peers. Step 5: Assess dividend sustainability.

FAQs

What’s a good PE ratio?

Depends on sector and growth. Below 15 is generally considered value; above 25 suggests growth pricing. Always compare within sector.

Can I use PE alone?

No. PE is starting point. Combine with PB, growth rates, and qualitative factors for complete picture.

Best metric for banking stocks?

PB ratio and ROE are primary. PE is secondary. NPA ratios and credit growth matter more than traditional metrics.