Valuation Metrics (P/E, P/B, EV/EBITDA, DCF)

Valuation metrics are essential tools for investors to determine whether a stock is overvalued, undervalued, or fairly priced. Different metrics provide unique insights into a company’s financial health, growth prospects, and market position. Below, we explore four of the most widely used valuation methods:

1. Price-to-Earnings Ratio (P/E)

The P/E ratio compares a company’s stock price to its earnings per share (EPS).

• Formula:

  P/E=Stock PriceEarnings Per Share (EPS)P/E=Earnings Per Share (EPS)Stock Price​

• Interpretation:

  • A high P/E may indicate growth expectations or overvaluation.

  • A low P/E could suggest undervaluation or declining earnings.

• Types:

  • Trailing P/E: Based on past earnings.

  • Forward P/E: Based on projected future earnings.

• Best for: Comparing companies in the same industry.

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2. Price-to-Book Ratio (P/B) Valuation Metric

The P/B ratio valuation metric measures a stock’s market value relative to its book value (net asset value).

• Formula:

  P/B=Stock PriceBook Value Per ShareP/B=Book Value Per ShareStock Price​

• Interpretation:

  • P/B < 1: Potentially undervalued (trading below book value).

  • P/B > 1: Investors are paying a premium over net assets.

• Best for: Asset-heavy industries (banks, real estate, manufacturing).

3. Enterprise Valuation Metrics: Value-to-EBITDA (EV/EBITDA)

This ratio evaluates a company’s total value (including debt) relative to its earnings before interest, taxes, depreciation, and amortization (EBITDA).

• Formula:

  EV/EBITDA=Enterprise Value (EV)EBITDAEV/EBITDA=EBITDAEnterprise Value (EV)​

  Where:

  $$\text{EV}=\text{Market Cap}+\text{Debt}-\text{Cash}$$

• Interpretation:

  • Lower ratios may indicate undervaluation.

  • Useful for comparing firms with different capital structures.

• Best for: Leveraged companies, M&A analysis, and capital-intensive sectors.

4. Discounted Cash Flow (DCF) Analysis

DCF estimates a company’s intrinsic value by forecasting future cash flows and discounting them to present value.

• Formula:

  DCF=∑CFt(1+r)t+Terminal Value(1+r)nDCF=∑(1+r)tCFt​​+(1+r)nTerminal Value​

  Where:

  • CFₜ = Cash flow in year *t*

  • r = Discount rate (WACC or required rate of return)

  • Terminal Value = Estimated value beyond the forecast period

• Interpretation:

  • If DCF > Current Stock Price → Undervalued.

  • If DCF < Current Stock Price → Overvalued.

• Best for: Long-term investors, growth companies stock, and private equity.

Which Valuation Metrics Should You Use?

• P/E: Quick valuation check for profitable companies.

• P/B: Useful for asset-driven businesses.

• EV/EBITDA: Better for leveraged or capital-intensive firms.

• DCF: Most comprehensive but requires detailed assumptions.

By combining these metrics, investors can gain a more complete picture of a company’s valuation and make more informed investment decisions.