Stock Valuation Metrics Explained: P/E, PEG, EV/EBITDA and 5 More

P/E = Share Price ÷ Earnings Per Share

The amount the market pays for each dollar of annual profit. A P/E of 20 means investors pay $20 for every $1 the company earns in a year. Inverted, it gives the earnings yield: a P/E of 20 is a 5% earnings yield, which is the more useful form when comparing a stock against a bond.

Typical ranges run from 8–14× for banks, utilities and cyclicals, 15–22× for consumer staples, healthcare and industrials, and 25–40× for software and other high-growth businesses. Those bands reflect growth rates, capital intensity and earnings predictability, which is exactly why cross-sector comparison fails.

Where it breaks

• Cyclicals. P/E is lowest at the earnings peak, which is the worst time to buy. The low multiple is the trap signal.
• Negative or near-zero earnings. The ratio becomes undefined or meaninglessly large.
• Heavy leverage. Two identically performing businesses show very different P/E ratios purely from capital structure.
• One-off items. A large write-down or asset sale can move reported earnings enough to make the multiple nonsense for a year.
• Aggressive accounting. Earnings are the most manipulable figure in the accounts, which is the argument for cross-checking against cash.

P/B = Share Price ÷ Book Value Per Share

How much the market pays relative to accounting net worth — assets minus liabilities. A P/B below 1.0 means the market values the company at less than the stated net value of what it owns. Graham leaned on this heavily, and it remains the most useful multiple for financials, where the balance sheet is the business.

Banks and insurers typically trade at 0.8–1.5×, capital-intensive industrials at 1.5–3×, and asset-light businesses anywhere from 8× to undefined.

Where it breaks

• Intangible-heavy businesses. Research, development and brand-building are expensed rather than capitalised, so decades of value creation can sit on the books at zero. Covered in detail below.
• Negative book value, which can indicate distress or simply years of buybacks at a healthy company. The ratio cannot distinguish between the two.
• Goodwill from acquisitions inflates book value with a figure that represents a price paid rather than an asset owned, and gets written off precisely when you least want it to.
• Historical cost accounting. Property bought in 1985 sits on the books at 1985 prices less depreciation, understating book value for asset-rich companies.

EV = Market Cap + Total Debt − Cash. EV/EBITDA = EV ÷ (Earnings before Interest, Tax, Depreciation and Amortisation)

The price of the entire business — what an acquirer would pay for the equity and assume in debt — against its operating cash generation before financing and accounting choices. This makes it the right tool for comparing companies with different capital structures, different depreciation policies or different tax jurisdictions, none of which EV/EBITDA is affected by.

Typical ranges: 5–8× for cyclicals and telecoms, 9–13× for industrials and consumer businesses, 15–25× for software. Below 6× for a stable business is genuinely cheap and worth investigating.

Where it breaks

• It ignores capital expenditure entirely. For a business that must spend heavily just to maintain its asset base, EBITDA overstates economic earnings badly. Buffett's objection stands: depreciation is a real expense, and treating it as an add-back pretends capital assets are free.
• Banks and insurers. Interest is operating revenue for a bank, so removing it makes no sense; EV/EBITDA does not apply to financials at all.
• Companies with large operating lease obligations, where the debt-like liability may not be fully captured in enterprise value depending on the accounting treatment.
• EBITDA is not a defined accounting measure, so companies have latitude in what they add back — "adjusted EBITDA" in particular deserves scrutiny.

Dividend Yield = Annual Dividend Per Share ÷ Share Price × 100

The cash return on the current price. Its most valuable use is not as an income measure but as an inverted valuation multiple: for a business with a stable payout ratio, a yield near the top of its own five-year range means the price is low relative to earnings. This is often the cleanest valuation signal available for a mature dividend payer.

Typical ranges: 0–1% for growth companies, 1.5–3% for quality dividend growers, 3–5% for mature businesses and utilities, 4–8% for REITs and MLPs where high distributions are structural.

Where it breaks

• A yield that rose because the price fell is a warning, not an opportunity. The market is usually forecasting a cut, and is usually right.
• It says nothing about sustainability on its own — always read it alongside the payout ratio and free cash flow cover.
• It ignores buybacks, which are economically similar. A company returning 4% through repurchases and 1% through dividends looks stingy on yield alone.
• Trailing yield can reflect a dividend already announced as being cut, or miss a special dividend that will not repeat.

Payout Ratio = Dividends Per Share ÷ Earnings Per Share × 100 (better: dividends ÷ free cash flow)

The share of profits paid out as dividends, and therefore the margin of safety on the dividend itself. The version measured against free cash flow is substantially more useful, because dividends are paid in cash and reported earnings can diverge from cash for years.

There is no universal safe level. Technology above 55% of free cash flow is stretched; consumer staples carry 60–75% comfortably; regulated utilities are fine at 65–75% of earnings; REITs must be judged on AFFO, where below 80% is comfortable.

Where it breaks

• REITs. Depreciation on property makes reported earnings meaningless, so a payout ratio of 150% of earnings can be 75% of AFFO and entirely safe.
• Cyclicals. A 25% payout at peak earnings can be 90% at the trough. Always assess against mid-cycle figures, never spot.
• Utilities. Capital expenditure expands the regulated rate base, so free cash flow is often negative by design and the earnings-based ratio is the correct one.
• Any year containing a large one-off charge, which depresses earnings and inflates the ratio without telling you anything about the dividend.

The trend matters more than the level. A ratio climbing from 45% to 72% over four years is a clearer warning than one that has sat at 70% for a decade.

PEG = P/E ÷ Earnings Growth Rate (%)

Normalises the P/E by the growth behind it, answering whether a high multiple is justified. Below 1.0 suggests growth is not fully priced in; 1.0–1.5 is fair value for a growing business; above 2.0 means the growth is priced and then some.

It is the central tool of GARP investing, and the full treatment — including forward versus trailing growth and the PEGY variant for dividend payers — is in the GARP guide.

Where it breaks

• Low growth rates. A company growing 2% at a P/E of 10 has a PEG of 5.0, which reads as wildly expensive when the business may be perfectly reasonably priced. Below roughly 8% growth, use free cash flow yield instead.
• Cyclical peaks and recovery base effects both produce enormous trailing growth rates and tiny, meaningless PEGs.
• It ignores the balance sheet completely. A PEG of 0.7 with net debt at 5× EBITDA is not cheaper than 1.1 with net cash.
• The denominator is a choice. Forward estimates are systematically optimistic; trailing figures are distorted by the cycle.

FCF Yield = Free Cash Flow ÷ Market Cap × 100. FCF = Operating Cash Flow − Capital Expenditure

The cash the business generates, after the spending required to keep it running, as a percentage of what you pay for it. It is the closest thing to an owner's return on purchase price, and the hardest of these metrics to manipulate — cash movements are considerably more difficult to massage than accrual earnings.

Above 5–6% generally indicates a reasonably priced or cheap business. Above 10% is either genuinely cheap or a signal that the market expects the cash flow to fall.

Where it breaks

• It cannot separate maintenance capex from growth capex. A company investing heavily in expansion shows poor FCF yield precisely because it is doing something valuable.
• Working capital swings distort single years badly. Use a three-to-five-year average.
• It is an equity measure and ignores debt. Pair it with net debt/EBITDA, or use the enterprise-level FCF/EV variant.
• Financials, where the concept of capital expenditure does not carry the same meaning.

Net Debt / EBITDA = (Total Debt − Cash) ÷ EBITDA

Roughly how many years of operating cash generation it would take to repay all debt. Not a valuation metric — a solvency one, and the check that determines whether a cheap valuation is an opportunity or a warning. It is the most commonly skipped metric on this page and the one whose absence causes the most permanent losses.

Below 1.0× is conservative, 1.0–2.5× is comfortable for most businesses, 2.5–3.5× warrants attention, and above 4× means the lenders effectively have a say in capital allocation.

Where it breaks

• Sector norms differ enormously — utilities and REITs routinely operate at 4–6× and are not distressed, because their cash flows are contracted or regulated.
• It uses EBITDA, so it inherits every EBITDA problem, particularly for capital-intensive businesses.
• It says nothing about maturity timing. Debt due in eighteen months and debt due in a decade produce the same ratio and entirely different risks.
• Cash held overseas or otherwise restricted may not actually be available to repay debt.

P/E prices the equity; EV/EBITDA prices the whole business. Five situations make the second one clearly correct.

1. 1The company has negative earnings but positive EBITDA. P/E is undefined; EV/EBITDA still works and often shows a viable business carrying heavy depreciation or interest.
2. 2You are comparing companies with materially different leverage. P/E is distorted by capital structure by construction — a leveraged company shows a lower P/E for identical operations. EV/EBITDA removes the distortion.
3. 3You are comparing across tax jurisdictions or depreciation policies. Both flow through net income and neither tells you anything about the business.
4. 4The company is capital-intensive with heavy depreciation — telecoms, cable, shipping. Reported earnings are dominated by a non-cash charge and understate cash generation.
5. 5You are thinking about the business as an acquirer would. An acquirer assumes the debt, so enterprise value is the price they actually pay.

When to stay with P/E: financials, where interest is operating revenue and EV/EBITDA is not applicable; and asset-light businesses with minimal debt and minimal depreciation, where the two converge and P/E is simpler.

When they disagree, the disagreement is the finding. P/E cheap and EV/EBITDA expensive means leverage is flattering the equity multiple — and the debt is now the most important thing to understand about the company. The reverse, P/E expensive and EV/EBITDA cheap, often marks a business with a strong net cash position that the equity multiple penalises.

A negative P/E means the company reported a net loss. It is not a low P/E — it is an undefined one, and the practical danger is that screens sorting by P/E ascending will place every loss-maker at the top of a list labelled "cheapest."

Discard the ratio and identify which of four situations applies:

In the first three cases, EV/EBITDA and free cash flow yield frequently still work, because a company can be unprofitable on a net income basis while generating real cash. That divergence is common in businesses with large depreciation charges or heavy amortisation of acquired intangibles.

One caution on the third case: "not yet profitable" and "unable to be profitable" look identical for several years. The distinguishing evidence is gross margin — a business with 70% gross margins losing money on operating expenses has a visible path; one with 15% gross margins does not.

Price-to-book has lost much of its power as a value screen, and the cause is an accounting rule rather than a change in markets.

Accounting standards require research and development, advertising and brand-building to be expensed in the period incurred rather than capitalised as assets. A pharmaceutical company that spent $40bn over fifteen years developing a drug portfolio, or a consumer company that spent decades building a brand, carries the resulting value on its balance sheet at zero. Meanwhile a company that acquired similar assets records them as goodwill and intangibles, and shows a much larger book value for economically identical positions.

The consequence is systematic. P/B classifies asset-light, high-return businesses as expensive growth stocks, and capital-heavy businesses as cheap value stocks — regardless of what either is actually worth. A record number of large US companies now report negative book value, and for a substantial share of them the cause is not distress at all.

The two causes of negative book value

• Accumulated losses exceeding paid-in capital. A genuine distress signal — the company has destroyed more equity than was ever contributed.
• Buybacks and dividends exceeding retained earnings. Repurchasing stock reduces equity on the balance sheet. A highly profitable company that has bought back stock aggressively for a decade can show negative equity while generating substantial free cash flow. Several large consumer and technology companies sit here.

The two are indistinguishable from the equity line alone. Look at free cash flow: strongly positive alongside negative book value means buybacks; negative alongside negative book value means distress.

For intangible-heavy businesses, replace P/B with free cash flow yield, EV/EBIT and return on invested capital. If P/B is the metric telling you a business with no significant physical assets is expensive, the metric is wrong rather than the market. P/B remains genuinely useful in exactly one place: financials, where the balance sheet is the business and assets are marked closer to fair value.

Earnings yield is the inverted P/E — net income divided by market cap. Free cash flow yield divides actual cash generated after capital expenditure by the same denominator. They answer the same question with different definitions of "return," and where they diverge, the divergence is diagnostic.

FCF yield is generally the more reliable of the two, for the straightforward reason that cash is harder to manipulate than earnings. It has also performed well historically as a ranking metric: in a long-run US study covering 1971–2010, the cheapest quintile by FCF yield returned roughly 16.6% annually against about 7–8% for the market, ranking second among all valuation ratios tested.

The useful practice is to compute both and read the gap:

• FCF yield well below earnings yield, persistently — capex exceeds depreciation. Either the company is investing for growth, or it must spend heavily just to stand still. Which one determines whether the low yield is good news.
• FCF yield well above earnings yield — large non-cash charges such as amortisation of acquired intangibles, or capex running below depreciation. The second is the concerning case: it flatters cash flow today and creates a problem later.
• A persistent gap where FCF is below net income by more than 20% over five years is a recognised accounting-quality warning. Earnings are being reported that never arrive as cash.

One correction to the usual framing: FCF yield is not simply better. A company investing heavily in a genuinely high-return expansion shows a poor FCF yield precisely because it is doing the right thing. The metric cannot separate maintenance capex from growth capex, and that distinction is often the most important fact about a business.

There is no single threshold, because the tolerable level depends on how predictable and how contracted the cash flows are. A regulated utility at 5× is ordinary; a semiconductor company at 5× is in trouble.

Utilities and REITs carry higher leverage because their cash flows are regulated or contracted, and because their assets are long-lived and financeable. Applying a technology-sector limit to a utility excludes the entire sector for no reason; applying a utility limit to a cyclical is how permanent losses happen.

Three things matter more than the ratio itself:

• Interest cover — EBIT divided by interest expense. Below 4× leaves no room for a bad year; below 2.5× and the lenders effectively control capital allocation. This is a better distress predictor than leverage alone.
• The maturity schedule. Debt due within twenty-four months into a higher rate environment is a completely different risk from the same amount maturing in 2034. The ratio treats them identically.
• Fixed versus floating. A company with mostly floating-rate debt has an income statement that moves with policy rates, which converts a manageable balance sheet into an unmanageable one without any change in leverage.

For cyclicals specifically, measure against mid-cycle EBITDA rather than trailing. A 2× ratio at peak earnings can be 6× at the trough, and the trough is when the covenants get tested.