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With valuation ratios, a company's stock price enters your investment analysis. Valuation ratios include the ever-popular price to earnings (P/E) ratio, along with price to sales (P/S), price to book (P/B), and a couple of boutique P/E variations.
Price to earnings
Price to earnings (P/E) is just what it sounds like: the ratio of a price at a point in time to net earnings in a period, usually the trailing 12 months (TTM). Here's the formula:
Price to earnings (P/E) = stock price / net earnings per share
A high P/E, say 20 or higher, indicates a relatively high valuation; a low P/E, say 15 or less, indicates a relatively low or more conservative one.
Earnings to price
Earnings to price, a deriviative of P/E, is simply the reciprocal of P/E, or 1 divided by the P/E. Why is this important? Earnings to price is the functional equivalent of a stock's yield, comparable to an interest rate on a fixed income investment. Because we're talking earnings and not dividends, this yield doesn't usually come your way in the form of a check, but it's useful just the same to determine how much return your dollar paid for a share is generating. Many people call this figure earnings yield.
Price/earnings to growth
When comparing businesses, one popular way to "normalize" P/Es is to compare them to their respective company's growth rate. From this comparison, get to know another derivative of P/E, price/earnings to growth, or PEG:
Price/earnings to growth (PEG) = (P/E) / earnings growth rate
 | The lower the PEG, the better. But if the low PEG is driven by high growth rates, you'd better be confident in the growth rate assumption. |
Price to sales
Per dollar of shareholder value, how much business does this company generate? Price to sales (P/S) is a straightforward way to answer this question. Here's the formula:
Price to sales (P/S) = stock price (total market cap) / total sales (revenues)
P/S is a common-sense ratio: The lower the better, although there's no specific rule or normalizing factor like growth. Somewhere around 1.0 is usually considered good.
| Don't read too much into the raw P/S number, especially when comparing companies in different industries. A company selling big-ticket items may have a very low P/S ratio. Ford Motor is an example, at 0.11. But low margins and high expenses reduce the profitability of those sales; Cisco, on the other hand, has much higher margins. |
Price to book
The price to book (P/B) ratio is getting varying amounts of attention from investors in different sectors:
Price to book (P/B) = stock price (total market cap) / book value
Book value consists of the accounting value of assets less (real) liabilities — sort of an accounting net worth or owner's equity of a corporation. This figure has greater meaning in financial services industries, where most assets are actual dollars, not factories, inventories, and other hard-to-value items.
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