What are P/E ratio and P/B ratio?
- P/E ratio
The price-to-earnings ratio, or P/E ratio, is a stock valuation metric that compares a company’s current stock price to its earnings per share (EPS), which can be calculated based on historical data or forward-looking estimates. The formula of the P/E ratio is:
P/E ratio = Share price / EPS
The P/E ratio indicates the dollar amount an investor can expect to invest in a company to receive $1 of that company’s earnings. If a company is currently trading at a P/E ratio of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings. Thus, a high P/E ratio could mean that a company's stock is overvalued, or that investors are expecting high growth rates in the future. A low P/E ratio may signal that the stock price doesn’t accurately reflect the true value of the company according to its earnings.
- P/B ratio
Price to book ratio, also known as the P/B ratio, is a stock valuation metric used to evaluate a company’s current market value relative to its book value. The book value is defined as the company’s total assets minus any liabilities. The P/B ratio is calculated by dividing the company's stock price per share by its book value per share (BVPS).
P/B ratio= Market Price per Share / Book Value per Share
-Market value per share is obtained by simply looking at the share price quote in the market.
-Book Value per Share: (total assets - total liabilities) / number of shares outstanding
P/B ratios under 1 are typically considered solid investments by value investors. While P/B ratios on the lower end can generally suggest a company is undervalued and P/B ratios on the higher end can mean the company is overvalued, a closer examination is still required before making any investment decision.