FINANCIAL BASICS: VALUATION RATIOS



"Can ratios help me evaluate stocks? If so, which ones?". The answer is yes! Market value or valuation ratios can help you.


Valuation ratios all consist of two parts: a value measure over a value driver like in the case of the P/E ratio, where price (P) is the value measure, and earnings (E) is the value driver. If a company has a P/E ratio of 10x, then the market price is 10x more than a company's earnings. If a company has a P/E ratio of 20x, then it is selling for 20x its earnings, and is therefore more expensive.

Other commonly used valuation measures replace P and E for other value measures and drivers respectively that are a bit more comprehensive. Three common ratios used by investors and stock pickers are EV/EBITDA, EV/EBIT and EV/Sales. All of the above replace price (which is the value of a business’ equity), with Enterprise Value, which is the value of a business’ equity AND net debt. These ratios take the balance sheet into account, whereas the P/E ratio does not.

​​The lower this multiple is, the cheaper per share. If a company has an EV/EBITDA ratio of 15x (which is in the historical general average range of the S&P 500) then you would have to pay 15 times more than a company’s EBITDA profit to buy it!

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