What are valuation metrics like P E or PEG
Understand how valuation metrics help you see if a stock is cheap or expensive based on profit and growth.
Valuation: price vs quality (Explained for total beginners)
Ratios like P/E or EV/EBITDA help you compare a stock to its sector and its own history. Here's how they work, step by step—no math degree needed. Learn more in our Trade & Tonic Learning Center.
P/E Ratio (Price-to-Earnings): This shows how much you're paying for each dollar of the company's profits.
Formula: P/E = Stock Price ÷ Earnings Per Share (EPS).
EPS is "profit per share" (company's total profit ÷ total shares).
Example: Stock at $100, EPS $5 → P/E = 20. You pay $20 for every $1 of profit.
What it means:
Low P/E (under 15): Possibly cheap (bargain or slow grower).
Average (15-25): Fair for most stocks.
High (30+): Investors expect fast growth (tech stocks often here).
How to use: Compare to the industry average (e.g., banks ~12, tech ~30) or the stock's 5-year average. Find it on Yahoo Finance under "Statistics."
EV/EBITDA (Enterprise Value to Earnings Before Interest, Taxes, Depreciation & Amortization): Like P/E but accounts for debt, making it better for fair comparisons.
Formula: EV/EBITDA = (Market Cap + Debt - Cash) ÷ EBITDA.
EV: "True cost to buy the company" (stock value + debt - cash on hand).
EBITDA: Core operating profit (ignores taxes, interest, one-time costs).
Example: EV $105B, EBITDA $15B → 7x. Good range: 5-12 (lower = cheaper).
Why better than P/E?: Ignores debt differences—two similar companies, one loaded with loans? EV/EBITDA shows the risky one as pricier.
How to use: Ideal for long-term; compare across sectors or peers.
Quick comparison table:
Ratio | Beginner Meaning | Formula (Simplified) | Good Beginner Range | Best For Long-Term |
|---|---|---|---|---|
P/E | $ paid per $1 profit | Price ÷ EPS | 15-25 | Quick screen |
EV/EBITDA | Total buyout cost per $1 ops profit | EV ÷ EBITDA | 6-12 | Debt-adjusted |
Warren Buffett warns: “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Ratios spot that fair price.