When people start investing, they often find it difficult to understand whether a stock is expensive or reasonably priced. That’s where valuation ratios come in. Among them, the Price-to-Earnings (P/E) ratio and Price-to-Book (P/B) ratio are two of the most commonly used indicators to judge a company’s value. These ratios do not guarantee profits, but they help investors make more informed decisions.
What is the P/E Ratio?
The P/E ratio shows how much investors are willing to pay today for the company’s earnings. It connects a stock’s market price with the profit the company makes per share.
Formula:
P/E Ratio = Share Price ÷ Earnings Per Share (EPS)
The P/E ratio is essentially a reflection of market expectations.
- A high P/E ratio usually suggests that investors expect the company to grow strongly in the future. Sectors like IT, FMCG, and pharma often trade at higher P/E multiples.
- A low P/E ratio may indicate that the stock is undervalued or that the company’s future performance is uncertain.
Example
If a stock trades at ₹200 and the company generates an EPS of ₹10, the P/E ratio would be:
200 ÷ 10 = 20
This means investors are paying ₹20 for every ₹1 the company earns.
When is P/E useful?
- When comparing companies within the same sector
- For profitable businesses
- For understanding market confidence and growth expectations
What is the P/B Ratio?
The Price-to-Book (P/B) ratio helps investors understand how the market values the company’s net assets. Book value refers to the company’s assets minus its liabilities.
Formula:
P/B Ratio = Share Price ÷ Book Value per Share
The P/B ratio helps identify whether the market is valuing a company higher or lower than the worth of its physical assets.
- A P/B below 1 may mean the stock is undervalued and trading below its actual asset value.
- A P/B between 1–3 is considered healthy for most companies.
- A P/B above 3 usually indicates strong investor confidence or that the company operates with fewer tangible assets (for example, technology businesses).
Example
If a share is priced at ₹300 and its book value per share is ₹100, then:
300 ÷ 100 = 3
This means investors are ready to pay ₹3 for every ₹1 of the company’s net assets.
When is P/B useful?
- For banks, NBFCs, and manufacturing companies
- For companies with significant tangible assets
- For identifying undervalued opportunities during market correction
P/E vs P/B: What’s the Difference?
| Aspect | P/E Ratio | P/B Ratio |
|---|---|---|
| Measures | Price vs Earnings | Price vs Company Assets |
| Best For | Profitable and growing companies | Asset-heavy sectors like banking |
| Indicates | Growth expectations | Whether stock is undervalued or overvalued based on assets |
In simple terms, P/E tells you how expensive the stock is compared to its profits, while P/B tells you how expensive it is compared to its net assets.
Why Should Investors Care About These Ratios?
No single ratio can tell the whole story about a company, but P/E and P/B provide a strong foundation for evaluating a stock. Together, they help you answer key investment questions:
- Is the stock overpriced?
- Is it available at a fair value?
- Does the company justify its current market price?
By combining these ratios with other metrics like ROE, Debt-to-Equity, and future growth prospects, investors can build a clearer picture of the company’s true value.
Conclusion
Understanding P/E and P/B ratios is essential for anyone who wants to invest confidently. These simple yet powerful tools help investors compare companies, identify undervalued opportunities, and avoid overpriced stocks. While they should not be used in isolation, they serve as the first step towards informed and intelligent investing.
