Valuation Metrics
Fundamental Analysis • Intermediate Level
Valuation metrics are essential tools that help investors determine whether a stock is fairly priced, overvalued, or undervalued. These quantitative measures compare a company's stock price or market value to its financial performance, providing insights into investment opportunities and risks.
1Price Ratios
Price-to-Earnings (P/E) Ratio
Definition: Compares stock price to earnings per share, indicating how much investors are willing to pay for each dollar of earnings.
P/E = Price per Share ÷ Earnings per Share
Interpretation:
- • Low P/E (5-15): Potentially undervalued or slow growth
- • Moderate P/E (15-25): Fair valuation for stable companies
- • High P/E (>25): Growth expectations or overvaluation
Price-to-Book (P/B) Ratio
Definition: Compares market value to book value, showing how much investors pay for each dollar of net assets.
P/B = Price per Share ÷ Book Value per Share
Interpretation:
- • P/B < 1: Trading below book value (potential value)
- • P/B 1-3: Reasonable valuation range
- • P/B > 3: Premium valuation or asset-light business
Price-to-Sales (P/S) Ratio
Definition: Compares market capitalization to total revenue, useful for companies with inconsistent earnings.
P/S = Market Cap ÷ Total Revenue
Interpretation:
- • P/S < 1: Potentially undervalued
- • P/S 1-4: Reasonable for most industries
- • P/S > 4: High growth expectations or overvaluation
PEG Ratio
Definition: Adjusts P/E ratio for growth rate, providing a more complete valuation picture for growing companies.
PEG = P/E Ratio ÷ EPS Growth Rate (%)
Interpretation:
- • PEG < 1: Potentially undervalued growth stock
- • PEG ≈ 1: Fair value considering growth
- • PEG > 1: May be overvalued relative to growth
2Enterprise Value Ratios
Enterprise Value (EV): Market Cap + Net Debt. Represents the total value of a company, including both equity and debt holders' claims.
EV/EBITDA
Definition: Compares total firm value to earnings before interest, taxes, depreciation, and amortization.
EV/EBITDA = (Market Cap + Net Debt) ÷ EBITDA
Interpretation:
- • Enables comparison across different capital structures
- • EV/EBITDA < 8 often attractive in mature industries
- • Higher ratios acceptable for growth companies
EV/Sales
Definition: Compares total firm value to revenue, useful for early-stage companies with negative EBITDA.
EV/Sales = (Market Cap + Net Debt) ÷ Total Revenue
Typical Ranges:
- • 0.5-3×: Most industries
- • <1×: Potentially undervalued
- • >5×: High growth or premium sectors
3Profitability & Efficiency Ratios
Return on Equity (ROE)
Definition: Measures profitability relative to shareholder equity, indicating how efficiently a company uses shareholders' investments.
ROE = Net Income ÷ Average Shareholder Equity
Interpretation:
- • ROE > 15%: Strong competitive advantages
- • ROE 10-20%: Good equity efficiency
- • ROE < 10%: May indicate inefficient capital use
Return on Assets (ROA)
Definition: Gauges how efficiently assets generate profits, showing management's effectiveness in using company resources.
ROA = Net Income ÷ Average Total Assets
Interpretation:
- • ROA > 8%: Effective asset utilization
- • ROA 5-10%: Typical range for most companies
- • Compare within industries—capital-intensive firms have lower ROA
4Leverage Ratios
Debt-to-Equity (D/E) Ratio
Definition: Compares total debt to shareholder equity, measuring financial leverage and risk.
D/E = Total Debt ÷ Shareholder Equity
Interpretation:
- • D/E < 1: Conservative use of debt
- • D/E 1-2: Moderate leverage
- • D/E > 2: Elevated financial risk
Interest Coverage Ratio
Definition: Assesses ability to service interest payments, indicating financial stability and debt management.
Interest Coverage = EBIT ÷ Interest Expense
Interpretation:
- • Ratio > 5: Comfortable interest coverage
- • Ratio 3-5: Adequate coverage
- • Ratio < 2: Solvency concerns under stress
5Income & Cash Flow Yield Metrics
Dividend Yield
Definition: Annual dividends per share relative to share price, indicating income generation from stock ownership.
Dividend Yield = Annual Dividend per Share ÷ Share Price
Interpretation:
- • 2-5%: Common for mature companies
- • >8%: May signal dividend risk
- • Consider dividend sustainability and payout ratio
Free Cash Flow Yield
Definition: Free cash flow relative to market capitalization, showing cash generation efficiency.
FCF Yield = Free Cash Flow ÷ Market Capitalization
Interpretation:
- • Higher yield indicates more cash per dollar of equity
- • 4-8%: Typical range for healthy companies
- • Combine with balance sheet strength assessment
📊Key Valuation Metrics Summary
| Metric | Formula | Typical Range | Key Insight |
|---|---|---|---|
| P/E | Price ÷ EPS | 10-25× | Earnings valuation |
| P/B | Price ÷ BVPS | 1-3× | Asset-based valuation |
| P/S | Market Cap ÷ Revenue | 1-4× | Revenue valuation |
| PEG | P/E ÷ EPS Growth % | ~1 | Growth-adjusted valuation |
| EV/EBITDA | (Market Cap + Net Debt) ÷ EBITDA | 6-12× | Capital structure–neutral valuation |
| EV/Sales | (Market Cap + Net Debt) ÷ Revenue | 0.5-3× | Top-line valuation |
| ROE | Net Income ÷ Avg Equity | 10-20% | Equity efficiency |
| ROA | Net Income ÷ Avg Assets | 5-10% | Asset utilization |
| D/E | Total Debt ÷ Equity | <1-2× | Financial leverage |
| Interest Coverage | EBIT ÷ Interest Expense | >3-5× | Debt-servicing ability |
| Dividend Yield | Dividends per Share ÷ Price | 2-5% | Income generation |
| FCF Yield | Free Cash Flow ÷ Market Cap | 4-8% | Cash-generation relative value |
Key Takeaways
Best Practices
- Compare metrics within the same industry for accurate benchmarking
- Use multiple metrics together for comprehensive analysis
- Consider historical trends and future growth prospects
Common Pitfalls
- Relying on a single metric for investment decisions
- Ignoring industry context and business cycles
- Focusing on point-in-time data without trend analysis