Stock research guides · Guide 4 of 10
Stock valuation ratios explained: P/E, P/S, P/FCF, EV/EBITDA, PEG and DCF
What each valuation multiple compares, how it is calculated, and why a low or high number is a question about expectations rather than an answer.
Key takeaways
- Valuation ratios describe the expectations built into a price; they are not verdicts on their own.
- Earnings, sales and free cash flow ratios use different bases, so they can point in different directions.
- Enterprise value adds debt and subtracts cash, which helps when comparing differently financed companies.
- A DCF margin of safety is only as reliable as its growth, reinvestment and discount-rate assumptions.
A valuation ratio sets a company's share price against something the business produces: earnings, sales, cash flow or assets. By the end of this guide you will know how the common ratios are calculated and what each leaves out, which matters because one price can look cheap on one measure and expensive on another.
Check the date, window and peers first
A ratio sets one day's price against figures from a period (the last financial year, the trailing twelve months or a forecast), so sources using different windows disagree. Multiples also vary by industry: compare similar companies and the company's own history, not the whole market.
Price to earnings and what it assumes
The price-to-earnings ratio (P/E) shows how much investors pay for each unit of annual profit.
P/E = share price ÷ earnings per shareA trailing P/E uses reported earnings, usually for the last twelve months; a forward P/E uses analysts' forecasts and inherits their errors. Reported earnings can also include one-off gains or losses.
Take a hypothetical company whose shares trade at 40 with trailing earnings per share (EPS) of 2: a P/E of 20. Analysts forecast EPS of 2.50 next year, a forward P/E of 16. But if a one-off restructuring charge of 0.50 a share cut last year's profit, underlying EPS was already 2.50: the lower forward multiple reflects a charge not repeating, not growth.
A low P/E can signal genuine value or profits expected to shrink; a high one, strong expected growth or temporarily depressed earnings. Negative earnings make P/E meaningless.
Price to sales, price to book and price to free cash flow
P/S = market capitalisation ÷ revenueP/B = share price ÷ book value per shareFree cash flow = operating cash flow − capital expenditureP/FCF = market capitalisation ÷ free cash flowPrice to sales (P/S) helps when profits are thin, uneven or negative, but ignores costs and margins. Two hypothetical companies valued at 1,000 million, each with revenue of 500 million, trade at 2 times sales; if one keeps 20% of revenue as net profit and the other 2%, their P/Es are 10 and 100. Read it alongside margins, asking whether sales can become lasting profit.
Price to book (P/B) compares the price with book value, or net assets, per share. It suits banks and insurers, whose assets are largely financial, but says little where unrecorded assets such as brands drive the business.
Price to free cash flow (P/FCF) shows what investors pay for cash left after investment. A hypothetical company valued at 4,000 million, with operating cash flow of 300 million and capital expenditure of 100 million, has free cash flow of 200 million and a P/FCF of 20. If a new factory lifts capital expenditure to 250 million, free cash flow falls to 50 million and P/FCF rises to 80, even if the factory pays off later.
Postponing essential maintenance does the reverse, flattering free cash flow until the spending catches up. Working capital shifts cash between years too, when customers pay later or inventory builds up, so check several years across the business cycle.
Enterprise value, EV/EBIT and EV/EBITDA
Enterprise value (EV) approximates the price of the whole business: a buyer takes on its debt and gets its cash.
Enterprise value = market capitalisation + debt − cashEV/EBIT = enterprise value ÷ earnings before interest and taxEV/EBITDA = enterprise value ÷ (EBIT + depreciation + amortisation)This is simplified: fuller versions add minority interests and preference shares. Take two hypothetical companies valued at 1,000 million, each with EBIT of 100 million. One holds 200 million of cash and no debt, giving an EV of 800 million and EV/EBIT of 8; the other owes 600 million with no cash, giving 1,600 million and 16.
EBITDA adds back depreciation and amortisation, the accounting charges for using up assets, but it is not free cash flow: worn-out equipment must be replaced with real cash, and interest, tax and working capital still need paying. Two hypothetical companies on 10 times EBITDA of 500 million, with depreciation and amortisation of 50 million and 300 million, trade at about 11 and 25 times EBIT.
PEG, free cash flow yield and the Graham number
PEG = P/E ÷ annual EPS growth rate (15 for 15%)Free cash flow yield = free cash flow ÷ market capitalisation × 100Graham number = √(22.5 × EPS × book value per share)Price to Graham number = share price ÷ Graham numberA hypothetical P/E of 30 with EPS growing 15% a year gives a PEG of 2; with 30% growth, 1. Growth can mean last year's change, a multiyear average or a forecast, and the choice matters. EPS recovering from 1 to 2 after a bad year is 100% growth, giving a P/E of 20 a PEG of 0.2 that says nothing about durability. Negative growth makes PEG meaningless.
Free cash flow yield inverts P/FCF: the company above, on a P/FCF of 20, yields 5%. It is not a dividend yield: the company may reinvest, repay debt or buy back shares, and none of that cash is guaranteed to reach you.
The Graham number rests on Benjamin Graham's guideline that P/E times price to book should not exceed 22.5, such as 15 times earnings and 1.5 times book value. A hypothetical company with EPS of 2 and book value of 20 per share has a Graham number of √900, or 30; at a price of 45, price to Graham number is 1.5. The measure is conservative, penalises asset-light businesses and cannot be calculated when EPS or book value is negative; see the deep value guide.
Discounted cash flow and the margin of safety
A discounted cash flow (DCF) model values a business from the cash it may generate, discounting future amounts at a rate that reflects interest rates and risk. The margin of safety, an idea associated with Graham, compares that estimate with the price.
Present value = future cash flow ÷ (1 + discount rate)^years aheadValue per share = next year's free cash flow per share ÷ (discount rate − growth rate)Margin of safety = (estimated value − share price) ÷ estimated value × 100The second line is the simplest DCF, assuming steady growth forever; fuller models forecast each year. Some providers, dotQuant's Key Metrics panel among them, divide the margin of safety by the price instead of the estimate, which gives a larger figure for the same positive gap. For a hypothetical company with next year's free cash flow at 6 per share and shares at 80, moving each assumption one percentage point gives:
| Scenario | Discount rate | Growth rate | Estimated value | Margin of safety |
|---|---|---|---|---|
| Cautious | 10% | 2% | 75 | −7% |
| Base | 9% | 3% | 100 | 20% |
| Optimistic | 8% | 4% | 150 | 47% |
Faster growth usually needs more reinvestment, leaving less free cash flow, so inputs must be consistent. Treat any cushion as a research hypothesis, not protection: a modelled value is not a price forecast, and prices can fall as well as rise.
Valuation ratios at a glance
| Ratio | What it compares | Useful when | Watch out for |
|---|---|---|---|
| P/E | Price with EPS | Profits are steady | One-offs, negative earnings |
| P/S | Market value with revenue | Profits are thin | Ignores costs and margins |
| P/B | Price with book value | Assets are mainly financial | Unrecorded intangible assets |
| P/FCF | Market value with FCF | Earnings and cash diverge | Lumpy investment, working capital |
| EV/EBIT | EV with operating profit | Financing differs | Varying EV definitions |
| EV/EBITDA | EV with EBITDA | Financing and tax differ | Ignores replacement spending |
| PEG | P/E with EPS growth | Growth rates differ | Growth definition, durability |
| FCF yield | FCF with market value | Comparing cash generation | Not a dividend |
| Price to Graham number | Price with a conservative estimate | Profitable, asset-backed firms | Penalises asset-light firms |
| DCF margin of safety | Price with a modelled value | Testing assumptions | Small changes, big swings |
Putting it into practice on dotQuant
On a symbol page, the Key Metrics panel shows fundamentals "as of" the report date, over up to five years. Its "Valuation" group is headed by "Price to earnings", with a badge from fixed bands: "Cheap" up to 15, "Fair" up to 30 and "Expensive" above. The rows are "Price to book", "Price to sales", "Price to free cash flow", "Enterprise value to EBITDA", "Enterprise value to EBIT", "Price/earnings to growth", "Free cash flow yield", "Price to Graham number" and "Discounted-cash-flow margin of safety".
The bands are the same for every sector, so the badge is a starting point, not a conclusion. Valuation rows carry no year-over-year comparison, so their "Y/Y change" column shows a dash: not shown, rather than zero.
The "Discounted-cash-flow margin of safety" row is one fixed model applied to every company, not a forecast. It grows the latest free cash flow for ten years at the company's multi-year earnings-per-share growth rate when that lies between 3% and 15% (8% otherwise), discounts at 9%, adds a terminal value of 15 times the tenth year's cash flow, and divides the gap between that estimate and the market capitalisation by the market capitalisation. Identical assumptions make it a consistent screen across companies, and they also mean it will misjudge any business whose growth, risk or reinvestment needs differ from them.
Without an account you can search any symbol and read the panel; a guest watchlist lives only in that browser, and a persistent one needs an account. See the Key Metrics documentation.
Common questions
Is a low P/E ratio good?
Not on its own. It can reflect an overlooked, sound business, or profits expected to fall, a one-off gain or a cyclical peak; compare similar companies and the company's history.
Why do P/E ratios differ between websites?
Sources mix reported and adjusted, trailing and forward earnings, with different price dates and share counts. Check the definition and date first.
Further reading
- Profitability and growth metrics: the margins and growth behind the multiples.
- Financial health and capital allocation: the debt inside enterprise value.
- Deep value and quality compounders: Graham estimates in two investing styles.
- Investor.gov glossary: price-earnings ratio: the US regulator's definition.
- Aswath Damodaran's current data sets: industry multiples from NYU Stern.