PE and PB Ratios Explained

In stock market investing, valuation ratios are essential tools for assessing whether a stock is overvalued, undervalued, or fairly priced. Two of the most widely used ratios are the Price-to-Earnings (PE) ratio and the Price-to-Book (PB) ratio. They provide insight into a company’s earnings performance and asset-based value, helping investors make informed decisions.

Here’s how these two valuation metrics differ in what they reveal about a company’s worth:

• PE Ratio – The Price-to-Earnings ratio measures how much investors are willing to pay for each unit of a company’s earnings.
  Formula: PE Ratio = Price per Share ÷ Earnings per Share (EPS)
  

• PB Ratio – The Price-to-Book ratio compares the market price of a stock with its book value. Book value is the net asset value of the company after subtracting liabilities from total assets.
  Formula: PB Ratio = Price per Share ÷ Book Value per Share

Both ratios give different perspectives on valuation — PE focuses on profitability, while PB focuses on asset value.

Here’s how these calculations work in practice to interpret a stock’s valuation:

Example:

• Price per Share: ₹500
  

• EPS: ₹25
  

• Book Value per Share: ₹200
  

PE Ratio = ₹500 ÷ ₹25 = 20
This means investors are paying ₹20 for every ₹1 the company earns annually.

PB Ratio = ₹500 ÷ ₹200 = 2.5
This means the stock is trading at 2.5 times its book value.

Here’s how investors typically apply PE and PB ratios in practical stock analysis:

• Screening Stocks – These ratios can be used to filter stocks based on valuation benchmarks.
  

• Comparing with Industry Averages – Helps assess whether a stock is priced higher or lower than peers.
  

• Identifying Red Flags – Extremely high or low ratios could indicate overvaluation, undervaluation, or potential financial stress.
  

For example, a stock with a low PE ratio compared to its industry average might be undervalued if its earnings are stable. Similarly, a low PB ratio might signal undervaluation if the company’s assets are sound and market conditions are stable. However, both require additional qualitative analysis before making an investment decision.

In the banking and financial sector, book value reflects the realisable value of assets, making PB ratio a more accurate measure than PE in some cases. Banks with a PB ratio below the industry average may be trading at a discount — provided their asset quality is strong.

Neither ratio should be used in isolation. Combining them with other metrics such as:

• Return on Equity (ROE) – to assess profitability relative to equity.
  

• PEG Ratio – to adjust PE for earnings growth
  

• Non-Performing Assets (NPA) – especially for banks.

Avoid these common mistakes to ensure accurate analysis:

• Relying solely on PE or PB without considering the company’s industry.
  

• Ignoring qualitative factors such as management quality, market competition, or regulatory changes.
  

• Comparing ratios of companies from different sectors without adjustments.

The PE and PB ratios are fundamental tools for assessing stock valuations, but they work best when used together and alongside other indicators. PE gives insight into earnings potential, while PB reveals asset-backed value. It is useful to consider industry benchmarks, historical performance, and broader market conditions before making investment decisions.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.