Key Valuation Ratios

Once you can read the three financial statements, the next step is comparing what a stock costs to what the underlying business is actually worth — the essence of valuation. A handful of ratios, used together rather than in isolation, form the standard toolkit for this.

• P/E (Price-to-Earnings) — share price divided by earnings per share. Shows how much investors are paying for each rupee of current profit; a higher P/E generally reflects higher growth expectations.
• P/B (Price-to-Book) — share price divided by book value (equity) per share. Useful for asset-heavy businesses like banks, where a P/B below 1 can (but doesn't always) signal undervaluation.
• EPS (Earnings Per Share) — net profit divided by number of shares outstanding. The building block for the P/E ratio, and worth tracking for growth over time on its own.
• ROE (Return on Equity) — net profit divided by shareholders' equity. Measures how efficiently a company generates profit from the capital its owners have invested in it.
• Debt-to-Equity — total debt divided by shareholders' equity. A quick gauge of financial leverage and risk.
• Dividend Yield — annual dividend per share divided by share price. Matters more for income-focused investors than growth-focused ones.

No single ratio tells the whole story, and every ratio needs context to be useful. A P/E of 40 might be expensive for a slow-growing utility company and perfectly reasonable for a business compounding earnings at 30% a year. The right approach is always comparative: measuring a company's ratios against its own history, and against similar companies in the same industry, rather than treating any number as universally "good" or "bad" in isolation.

Valuation ratios are a starting point for asking better questions, not a formula that spits out a buy or sell decision. Combined with the balance sheet, income statement and cash flow statement covered in the previous three lessons, they give you the vocabulary to form an independent view on whether a stock's price actually reflects the business behind it.