Question 1

What is the P/E ratio and what does it tell me?

Accepted Answer

Price-to-Earnings ratio = stock price ÷ earnings per share (EPS). It tells you how much investors are paying for each dollar of profit. A P/E of 20 means investors pay $20 for $1 of annual earnings. Higher P/E implies higher growth expectations or premium quality; lower P/E may indicate value or slower growth.

Question 2

What is the difference between trailing and forward P/E?

Accepted Answer

Trailing P/E uses the last 12 months of actual reported earnings (backward-looking). Forward P/E uses the next 12 months of consensus estimated earnings (forward-looking). Forward P/E is lower than trailing when earnings are expected to grow, making the stock appear cheaper on a forward basis.

Question 3

What is the PEG ratio?

Accepted Answer

PEG = P/E ÷ annual EPS growth rate. It adjusts the P/E for growth: a stock with a P/E of 30 growing at 30% has a PEG of 1.0. A PEG below 1.0 is often considered undervalued relative to growth; above 2.0 may be expensive. Peter Lynch popularized PEG as a quick growth-adjusted valuation check.

Question 4

What does Price-to-Book (P/B) mean?

Accepted Answer

P/B = market cap ÷ book value (total assets minus total liabilities). A P/B below 1.0 means the stock trades below its net asset value — historically a value signal, though common for banks and capital-heavy industries. Asset-light tech companies routinely trade at P/B of 10× or more because their value lies in intangibles.

Question 5

What is EV/EBITDA and when is it useful?

Accepted Answer

Enterprise Value/EBITDA compares the total cost to buy a business (equity + debt − cash) to its pre-tax operating earnings. It is useful for comparing companies with different capital structures or tax rates. EV/EBITDA below 10× is often considered cheap for mature industries; high-growth sectors command 20–40×.

Question 6

How do I know if a stock is overvalued?

Accepted Answer

No single ratio definitively determines overvaluation. Compare the stock's current multiples to (1) its own 5-year historical average, (2) sector peers, and (3) the broader market. A stock trading at 2× its historical P/E while earnings growth is slowing is more likely to be expensive than one at 2× historical P/E with accelerating growth.

V P/E Ratio & Valuation Metrics