By now, you would have read the Beginners’ Guide to Financial Ratios and have gotten an understanding of the basic financial ratios.
Moving on, I’m sure you’ve heard of other ratios that are not so common like the Price-to-Book (P/B) and Price-to-Earnings (P/E) ratios.
Read on, as we simplify all these daunting financial concepts for you!
Price-to-Book (P/B) Ratio
P/B Ratio = Share Price / Equity per Share
The PB ratio is used to compare a firm’s market capitalisation to its book value. It is essentially how much you are paying for compared to what the company is worth.
An asset’s book value is equal to its value in the balance sheet, and it is calculated by netting the assets against its accumulated depreciation.
Used in conjunction with the Return on Equity ratio (ROE), overvalued growth stocks frequently show a combination of low ROE and high P/B ratios.
Price-to-Earnings (P/E) Ratio
P/E Ratio = Share Price / Earnings per Share
The P/E ratio measures the company’s current share price relative to its per-share earnings. They are used to determine the relative value of a company’s shares.
To do so, they are often benchmarked against other stocks in the same industry or against market indexes such as the S&P 500, in order to determine if the chosen stock is overvalued or undervalued.
Summary
These two ratios, while explained in simple terms here, are actually very powerful when used in combination with other ratios such as ROE, EPS, etc. It is important to note that these ratios should not be the sole factor deciding if the stock is over/undervalued as there are many other factors affecting the stock as well.
As usual, do your research properly if you are planning to pour your money somewhere!
