What are P/E and P/B ratios? How to calculate and use them

What is PE and PB in Share Market?

P/E and P/B ratios are relative valuation metrics that help investors identify whether a stock is overvalued or undervalued. These ratios are easy to calculate, and comparing them with the industry average or benchmarks like the S&P 500 can help inform investment decisions. In this article, we will discuss the P/E and P/B ratios in detail, how they’re calculated, and how they can be used to evaluate stocks.

What is the P/E ratio?

The full form of P/E ratio is the price-to-earnings ratio. It is a valuation metric that compares a company’s share price to its earnings per share (EPS). It is the price investors are willing to pay for every dollar of a company’s profit. The formula for calculating the P/E ratio is as follows:

How to Calculate PE Ratio?

P/E ratio = Market price per share / Earnings per share

The EPS can be calculated using past data or projected future outcomes. The trailing P/E represents the ratio using the last twelve months of the company’s earnings. Conversely, since companies can project earnings, investors can also calculate forward P/E using projected future earnings. A high P/E ratio suggests investors are willing to pay a premium for every dollar of profit a company generates. Conversely, because earnings can be negative, the P/E ratio can be negative as well. 

• If expectations of future earnings are high, the forward P/E ratio will usually be high. For example, companies in the tech sector tend to grow faster: as such, they typically have higher P/E ratios. As of this writing, companies in the information services industry have an average P/E ratio of 1,681.57 (roughly 100x the average P/E ratio of the S&P 500). A higher P/E ratio could also mean the company’s stock is overpriced – the market may have overestimated the company’s potential.

• On the other hand, if expectations of future earnings are low, the forward P/E ratio will also usually be low. For example, mature companies in stable sectors tend to be slower growing; as such, they typically have lower P/E ratios. As of this writing, the US steel industry has an average P/E ratio of 6.42 (less than half the average P/E ratio of the S&P 500). A lower forward P/E ratio could also mean that expectations are too low, which might translate to an investment opportunity as the market may have underestimated the company’s potential. 

What is the P/B ratio?

The PB full form in share market is the price-to-book ratio. It is a valuation metric that compares a company’s market value to the value of its assets. It is the price investors are willing to pay for every dollar of a company’s assets. 

How to Calculate PB Ratio?

The PB formula is as follows:

P/B ratio = Market price per share / Book value per share

P/B is calculated by dividing a company’s share price by its book value per share. The book value is calculated by subtracting intangible assets (such as brand value or intellectual property) and liabilities from total assets. A high P/B ratio suggests that investors are willing to pay a premium for the company’s book value. This might indicate that the company is receiving high returns on its assets. Conversely, a low P/B ratio might indicate that the company’s current stock price is undervalued relative to its assets. 

• If the return on assets is high, the P/B ratio also tends to be high. Typically, companies with significant intangible assets tend to have high P/B ratios since they are difficult to account for. For example, Apple had a P/B ratio of 67.88 in 2024 (roughly 15x the average P/B ratio of the S&P 500). A high P/B ratio could also mean the company’s stock is overpriced and investors are overconfident about its assets.

• On the other hand, if the return on assets is low, the P/B ratio also tends to be low. Typically, capital-intensive businesses such as banking or real estate have low P/B ratios. For example, America’s largest bank JPMorgan Chase has a P/B ratio of 1.4 (almost half the average P/B ratio of the S&P 500). A low P/B ratio could also mean the company’s stock is underpriced, which might translate to an investment opportunity as the market may have underestimated its assets.

How to use P/E and P/B ratios

Investors can use P/E and P/B ratios to assess different aspects of a company’s valuation. When using these ratios, investors should consider industry benchmarks and compare them with peers in the same sector. Here are a few things to consider when using these ratios:

• P/E ratios are particularly useful when evaluating growth stocks, as a high ratio may indicate market optimism and future earnings potential. However, the P/E ratio alone provides limited information about a company’s future earnings growth. It can be influenced by factors such as share buybacks or changes in accounting methods. Therefore, investors often use the Price/Earnings-to-Growth (PEG) ratio to take earnings growth into consideration. 

• P/B ratios are more relevant for asset-heavy industries, such as banking or real estate, where the ratio can highlight undervalued stocks based on their tangible assets. Nevertheless, it is important to note that P/B ratios do not consider intangible assets or other factors such as debt or capital depreciation. The book value of a company’s assets can also be manipulated by a company increasing or decreasing its cash reserve or doing share buybacks. For a comprehensive picture, investors can use the Return on Equity (ROE) indicator to see how much profit is being generated by the company’s assets. 

P/E vs P/B Ratio in Stock Market

Understanding the distinction between the P/E and P/B ratios is crucial for analyzing stocks in the share market:

Basis of Difference	P/E Ratio	P/B Ratio
Meaning	Compares the company’s current market price to its earnings per share.	Compares the company’s current market value to its book value.
Formula	Market Price of the Stock / Earnings Per Share	Market Capitalization / Net Book Value
Inference	It shows how many years it would take for the company to generate enough earnings to pay back the stock price.	Indicates whether the stock is undervalued or overvalued compared to its book value.

Conclusion

P/E and P/B ratios are essential tools for evaluating a company’s valuation and financial health. While the P/E ratio focuses on earnings performance, the P/B ratio assesses a company’s market value against its book value, making them complementary metrics. Together, they help investors make informed decisions tailored to different industries and market conditions.

Frequently Asked Questions (FAQs)

1)What are P/E and P/B ratios?

P/E and P/B ratios are relative valuation metrics used by investors to assess whether a stock is overvalued or undervalued.

2)How is the P/E ratio calculated?

The P/E ratio, or price-to-earnings ratio, is calculated by dividing the market price per share by the earnings per share (EPS) of a company.

3)How is the P/B ratio calculated?

The P/B ratio, or price-to-book ratio, is calculated by dividing the market price per share by the book value per share of a company.

4)What does a high P/E ratio indicate?

A high P/E ratio suggests that investors are willing to pay a premium for every dollar of profit a company generates. It may indicate market optimism and expectations of future earnings growth.

5)What does a low P/E ratio indicate?

A low P/E ratio suggests that the market may have underestimated the company’s potential. It could indicate undervaluation or low expectations of future earnings growth.

6)What does a high P/B ratio indicate?

A high P/B ratio suggests that investors are willing to pay a premium for the company’s book value. It may indicate high returns on assets or overconfidence about the company’s assets.

7)What does a low P/B ratio indicate?

A low P/B ratio suggests that the company’s current stock price is undervalued relative to its assets. It could indicate undervaluation or low returns on assets.