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Concept · Fundamentals

Valuation Basics

Is the stock cheap, expensive, or fair?

A great company can be a terrible investment if you overpay, and a mediocre one can be a bargain. Valuation ratios turn the financial statements into a quick read on how much you're paying for what you get. None is a verdict on its own — they're most useful compared to a company's own history, its peers, and its growth rate. As Warren Buffett put it, "Price is what you pay; value is what you get."

A ratio is just price measured against something the business produces Price (what you pay)share price, or whole-company value Per unit of valueearnings, sales, book value, cash flow P/E = price ÷ earnings per share "I'm paying $20 for every $1 of annual profit." Lower can mean cheaper — or slower-growing.
Every multiple compares the price against one thing the business produces — so always ask "price per unit of what?"

P/E — price to earnings

Share price ÷ EPS. The headline multiple: how many dollars you pay per dollar of annual profit. Trailing uses the last year's earnings; forward uses estimates. High P/E = the market expects growth (or the stock is expensive); low P/E = cheap, or troubled.

PEG — P/E adjusted for growth

P/E ÷ earnings growth rate. A high P/E can be justified by fast growth; PEG normalizes for it. Around 1 is often considered reasonable — a rough rule of thumb, not a law.

P/S and P/B

Price/Sales compares price to revenue — useful for young or unprofitable companies with no earnings yet. Price/Book compares price to net asset value (equity) — more meaningful for banks and asset-heavy businesses.

EV/EBITDA — the whole-company multiple

Enterprise value (market cap + debt − cash) ÷ earnings before interest, taxes, depreciation & amortization. Because it includes debt, it lets you compare companies with different capital structures more fairly than P/E.

Dividend yield

Annual dividend ÷ share price. What the stock pays you in cash to hold it. A very high yield can signal either a generous payer or a falling price the market distrusts.

Margin of safety

Benjamin Graham's core idea: only buy when price is meaningfully below your estimate of value, so you're protected if you're wrong. Valuation isn't about precision — it's about not overpaying.

Growth vs. value — two lenses

Value investors hunt for solid businesses trading below their worth (low multiples, a margin of safety — Graham and early Buffett). Growth investors will pay a high multiple for companies compounding fast, betting today's earnings understate tomorrow's (Peter Lynch's fast growers). Neither is "right" — they're different bets on what the price already reflects, which ties back to the idea of market efficiency.

See also