A valuation ratio compares what you pay to something the company produces or owns. Every one of them is a shortcut for the full discounted cash flow calculation, and every one of them fails in specific, predictable circumstances. Knowing those circumstances is most of the skill.
P/E — price to earnings
Example: A P/E of 28 means you are paying 28 rupees for each rupee of annual profit — roughly 28 years of current earnings to recover your investment, if profits never grow. The inverse, the earnings yield, is 1/28 = 3.6%.
| P/E works when | P/E breaks when |
|---|---|
| Earnings are positive and reasonably stable | The company is loss-making — the ratio is meaningless |
| Comparing companies in the same industry | The company is cyclical — see the trap below |
| The business is mature and predictable | Earnings contain large one-off items |
| Debt levels between the companies are similar | One company is debt-free and the other is heavily leveraged |
P/B — price to book
Price divided by book value per share, comparing market price to accounting net worth. It is the primary valuation tool for banks and financial companies, whose assets are financial and carried near fair value.
For asset-light businesses it is close to useless. A software services firm might have a P/B of 12, which sounds absurd until you remember that its actual assets — engineers, client relationships, code — do not appear on a balance sheet at all.
EV/EBITDA — the debt-aware ratio
- Enterprise value
- What it would cost to buy the whole business, including taking on its debt
- EV/EBITDA
- That total cost divided by operating cash earnings
Example: Two companies both earn ₹100 crore EBITDA and both have a market cap of ₹1,000 crore. One has zero debt; the other has ₹800 crore of debt. Their P/E ratios might look similar, but EV/EBITDA is 10 for the first and 18 for the second. The second is dramatically more expensive, and only this ratio shows it.
PEG — adjusting for growth
- Below 1.0
- Traditionally considered attractive — you are paying less than one point of P/E per point of growth
- Above 2.0
- Expensive relative to expected growth
Example: A company at 40× earnings growing 40% a year has a PEG of 1.0. One at 15× growing 5% has a PEG of 3.0. On this measure the "expensive" stock is the better value.
Choosing the right ratio
| Sector | Primary ratio | Why |
|---|---|---|
| Banks & NBFCs | P/B, with ROE | Assets are financial; book value is meaningful and leverage is structural |
| IT services | P/E | Asset-light, stable margins, minimal debt |
| FMCG & consumer | P/E, EV/EBITDA | Predictable earnings; brand value is off balance sheet |
| Cement, steel, commodities | EV/EBITDA, P/B | Cyclical earnings make P/E actively misleading |
| Telecom, infrastructure | EV/EBITDA | Heavy debt makes market cap alone deceptive |
| Loss-making growth companies | P/S, EV/Sales | No earnings to divide by — but be far more sceptical |
A cement company trades at a P/E of 5, its lowest in a decade, after four years of record profits driven by unusually high cement prices. What is the most likely situation?
Ek ghar ₹50 lakh ka hai aur ₹25,000 mahina kiraya deta hai — matlab saal ka ₹3 lakh. 50/3 ≈ 16 saal mein paisa wapas. Yahi PE ratio hai. Doosra ghar 40 saal wala hai — mehnga hai, par shayad us ilaake mein metro aa raha ho. PE akela nahi batata; wajah poochni padti hai.
- Every valuation ratio is a shortcut for a DCF, and every one fails in specific situations.
- For cyclicals a low P/E is a warning, not a bargain.
- EV/EBITDA is the only common ratio that accounts for debt.
- P/B is essential for banks and nearly meaningless for asset-light businesses.
- PEG is only as reliable as its growth forecast, which is usually optimistic.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- PE ratio meaning in share market
- The price-to-earnings ratio is the share price divided by earnings per share — how many rupees you pay for each rupee of the company’s annual profit. A P/E of 20 means the price is 20 times yearly earnings. It is most useful for comparing companies in the same industry and breaks down for loss-making or highly cyclical businesses.
- what does a PE ratio of 28 mean
- It means you are paying 28 rupees for every rupee of the company’s current annual profit — roughly 28 years of today’s earnings to recover your investment if profits never grew. The inverse is the earnings yield, 1 divided by 28, or about 3.6%. A high P/E is only justified if earnings are expected to grow.
- PEG ratio meaning
- The PEG ratio is the P/E divided by the expected earnings growth rate, and it exists because a high P/E can be reasonable if profits are growing fast. A PEG near 1 is often taken as a rough sign that the price and the growth are in balance, but it depends entirely on a growth forecast, which is an estimate and can be wrong.
- when does the PE ratio not work
- The P/E is meaningless when a company is loss-making, misleading when earnings contain large one-off items, and dangerous for cyclical businesses, where profits peak exactly when the ratio looks cheapest. It also distorts comparisons between a debt-free company and a heavily leveraged one, which is where EV/EBITDA becomes the fairer tool.