ATS: India’s Lowest-Cost Online Stock Trading Platform

11. What Are Valuation Ratios?

Valuation ratios are financial metrics used to assess the market value of a company relative to its financial performance, fundamentals, or assets. They help investors determine whether a stock is undervalued, fairly valued, or overvalued in relation to its earnings, book value, or cash flows.

These ratios are essential tools for:

Stock analysts
Portfolio managers
Individual investors

They are commonly used in stock screening, fundamental analysis, and investment decision-making.

Why Are Valuation Ratios Important?

Valuation ratios answer the critical question:
“Is the stock price justified by the company’s financial strength and potential?”

They enable investors to:

Compare companies within the same sector
Identify undervalued opportunities
Avoid overpriced stocks
Justify long-term holdings

Common Valuation Ratios

Ratio Name	Formula	What It Measures
P/E (Price to Earnings)	Market Price per Share ÷ Earnings per Share (EPS)	How much the market pays for each ₹1 of earnings
P/B (Price to Book)	Market Price per Share ÷ Book Value per Share	Market value vs the net asset value of the company
EV/EBITDA	Enterprise Value ÷ EBITDA	Valuation relative to core operational earnings
PEG Ratio	PE Ratio ÷ Earnings Growth Rate	Valuation adjusted for growth potential
Dividend Yield	Dividend per Share ÷ Market Price per Share	Cash return as % of stock price

Interpreting Valuation Ratios

Ratio	Low Value Means…	High Value Means…
PE Ratio	Undervalued (or weak earnings)	Overvalued or high-growth expectation
PB Ratio	Stock is cheap relative to net assets	Stock trades at premium to its book value
EV/EBITDA	Company is relatively inexpensive	Could be overpriced or highly leveraged
PEG Ratio	Reasonably priced considering growth	Growth might not justify current PE

Example Comparison

Company	PE Ratio	PB Ratio	EV/EBITDA	PEG Ratio
Infosys	27.5	9.3	17.2	1.8
TCS	30.1	14.2	21	2.1
HDFC Bank	18.6	2.9	10.3	1.4

HDFC Bank appears more attractively valued than the IT stocks based on PE and PB.
TCS commands a premium likely due to strong market positioning and brand.

Visual Flow: How Valuation Ratios Help Investors

Sector-Specific Benchmarks

Valuation ratios must be interpreted in context:

Sector	Typical PE Range	Typical PB Range	Notes
IT/Software	25 – 35	6 – 15	High margins, strong earnings growth
Banks	10 – 20	1 – 4	Book value is key due to asset-heavy model
FMCG	30 – 50	5 – 15	High PE due to brand strength and pricing power
Infrastructure	5 – 12	< 1.5	Capital-intensive, lower market valuation

Limitations of Valuation Ratios

Limitation	Explanation
Can be misleading in isolation	Must be compared across peers and industry
May ignore qualitative factors	Doesn’t factor in brand value, management quality, etc.
Prone to distortion	Earnings manipulation or market hype can skew ratios
Backward-looking	Most ratios use trailing data, may not capture future performance

Key Takeaways

Valuation ratios help determine whether a stock’s market price reflects its intrinsic worth.
Key ratios include P/E, P/B, EV/EBITDA, PEG, and Dividend Yield.
Always compare valuation ratios within the same industry or peer group.
Use in conjunction with growth metrics, profitability ratios, and qualitative analysis.
A low ratio doesn’t always mean “buy” and a high ratio doesn’t always mean “sell” — context is everything.