Valuation ratios compare what you pay for a company with what it earns, sells or owns. They make companies of very different sizes comparable and show whether the market expects a lot or a little from a company. A low ratio is not automatically cheap, and a high ratio is not automatically expensive.
P/E - price to earnings
The share price divided by earnings per share over the last year. A P/E of 20 means you pay 20 times one year's profit. It is the most used ratio, but it does not work for companies with losses and it is distorted by one-off gains or costs.
Turned upside down, the P/E becomes the earnings yield: 1 divided by the P/E. A P/E of 20 means the company earns 1/20 = 5 % of its share price in profit per year - net profit after all costs and tax, not revenue. A P/E of 10 is a 10 % earnings yield, a P/E of 40 only 2.5 %.
That makes a share comparable with a bond. If a government bond pays around 3-4 % a year, a 5 % earnings yield looks attractive, while a P/E of 50 (a 2 % earnings yield) only makes sense if profits are expected to grow strongly. The comparison is rough: the bond's interest is fixed and paid out, whereas a company's profit can grow or shrink, is only partly paid out as dividends, and the share carries more risk. When interest rates rise, investors usually demand a higher earnings yield, which pushes P/E ratios down - and the opposite when rates fall.
P/B - price to book
The share price divided by the book value (equity) per share. It is most useful for banks, insurers and other asset-heavy businesses. For software or brand-driven companies, much of the value is not on the balance sheet, so P/B says less.
EV/EBITDA
Enterprise value (market value plus debt minus cash) divided by earnings before interest, tax, depreciation and amortisation. Because it includes debt, it compares companies with different financing more fairly than P/E.
PEG - P/E to growth
The P/E divided by the expected yearly earnings growth in percent. A PEG around 1 is often read as a P/E that matches the growth; it is only as good as the growth estimate behind it.
Two examples with 20 % expected growth: a P/E of 18 gives a PEG of 0.9 - you pay a little less than the growth rate, which is often read as growth priced on the cheap side. A P/E of 22 gives a PEG of 1.1 - a small premium for the same growth. Below 1 is usually read as inexpensive relative to growth, clearly above 1 (2 or more) as expensive. The difference between 0.9 and 1.1 is small and well within the uncertainty of any growth forecast, so treat PEG as a starting point for comparing companies, not as a precise verdict.
Compare like with like
Ratios are most meaningful against the company's own history and against similar companies in the same sector. A utility and a software company will rarely have similar ratios, and that does not make one of them a bargain.
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