Stock Valuation Ratios: P/E, EPS, ROE and P/B

What valuation ratios are for

A valuation ratio links a company's share price to something in its accounts, such as profit or net assets. The ratio does not say whether a share is "cheap" or "expensive" on its own. It is a starting point for comparing a company with its own past, with similar companies, and with the wider market.

All the inputs come from financial statements: the income statement for profit, the balance sheet for equity. If these are new to you, read Financial Statements and What Stocks Are first.

EPS meaning: earnings per share

EPS (earnings per share) is the company's net profit available to ordinary shareholders, divided by the number of ordinary shares.

EPS = (Net profit − Preferred dividends) ÷ Weighted average ordinary shares

• Basic EPS uses the shares actually in issue during the period.
• Diluted EPS also counts shares that could be created from options, convertible bonds or similar instruments. It is usually lower, and it is the more cautious figure.
• Adjusted or "core" EPS is a figure management chooses to present without certain items. It is not standardised, so check what was removed.

What EPS misses

• One-off items. A gain from selling land or a large write-off can move EPS for a single period without saying anything about the ongoing business.
• Share count changes. Buybacks raise EPS even if profit is flat. Bonus issues and rights issues change the share count, so past EPS must be restated before comparing. See Splits and Rights Issues.
• Cash. EPS is an accounting profit. A company can report rising EPS while operating cash flow falls.
• Size. EPS in rupees cannot be compared between companies, because share counts and prices differ. That is why it is used inside ratios.

PE ratio: price to earnings

The PE ratio (price-to-earnings) shows how many rupees the market pays for each rupee of annual earnings per share.

P/E = Share price ÷ EPS

• Trailing P/E uses EPS from the most recent reported full year.
• Forward P/E uses analysts' estimated EPS for the coming year. It depends on forecasts that can be wrong.
• Earnings yield is the inverse, EPS ÷ Price. It lets you set a stock's earnings against interest rates on deposits or government securities.

A high P/E often means the market expects earnings to grow, or sees the earnings as stable and reliable. A low P/E can mean low expectations, higher perceived risk, or earnings at a cyclical peak that are expected to fall.

What the P/E ratio misses

• Loss-making companies. If EPS is zero or negative, P/E is meaningless.
• Debt. P/E looks only at the equity. Two companies with the same P/E can carry very different debt loads. Professionals often also use EV/EBITDA, which includes debt.
• Cycles. Cement, steel, chemical and commodity companies can show their lowest P/E at the top of the cycle, when profits are at their highest.
• Interest rates. When policy rates rise, investors usually demand a higher earnings yield, which tends to push P/E multiples down across the market. For the current State Bank of Pakistan rate, check SBP rates and economy or the SBP's own announcements, with the date.

ROE meaning: return on equity

ROE (return on equity) measures how much profit the company produces on the shareholders' money recorded on the balance sheet.

ROE = Net profit ÷ Average shareholders' equity

Analysts often split ROE into parts, known as the DuPont breakdown:

ROE = Net margin × Asset turnover × Financial leverage

• Net margin = Net profit ÷ Revenue
• Asset turnover = Revenue ÷ Total assets
• Financial leverage = Total assets ÷ Equity

This shows why ROE is high. It may come from strong margins, efficient use of assets, or simply heavy borrowing.

What ROE misses

• Debt-driven ROE. More borrowing shrinks equity relative to assets and lifts ROE, but it also raises risk.
• Buybacks and losses. Both reduce equity. A company with accumulated losses can show a high or even negative-equity ROE that means nothing.
• Asset values. Old assets carried at low historical cost make equity small and ROE look better.
• Price. ROE says nothing about what you pay for the share. A great business at a very high price is a different proposition from the same business at a lower price.

Price to book ratio

The price to book ratio (P/B) compares the share price with the net assets per share in the accounts.

P/B = Share price ÷ Book value per share Book value per share = (Total assets − Total liabilities) ÷ Ordinary shares

A P/B below one means the market values the company below its accounting net assets. That can reflect doubts about asset quality, weak returns, or a genuine discount.

What P/B misses

• Intangibles. Software, brands and service companies have most of their value in things not shown fully on the balance sheet, so their P/B is naturally high.
• Asset quality. For banks, book value depends on how honestly bad loans are provisioned.
• Revaluations. Some companies revalue property; others keep historical cost. Book values are then not like-for-like.

How the ratios fit together

Because EPS, equity and price are linked, the ratios are connected:

P/B = P/E × ROE (when both use the same earnings figure)

So a company with a high ROE can justify a higher P/B at the same P/E. A low P/B combined with a low ROE is often not a bargain but a fair reflection of weak returns. Reading the ratios together is more useful than reading any one alone.

Sector differences

Ratios only make sense against companies with similar business models.

Dividends are another lens, especially for income-focused shareholders. See Dividends.

Using these ratios in Pakistan

For companies listed on the Pakistan Stock Exchange, the source for EPS, equity and share counts is the company's published annual and quarterly reports. Compare ratios calculated from the same period and the same EPS type. Background on the market itself is in PSX basics.

Buying and selling listed shares is regulated: the supervisor is the Securities and Exchange Commission of Pakistan (SECP), with trading in listed securities and commodities only via SECP-licensed securities and futures brokers, and per the SECP, lists of licensed brokers are on the PSX and PMEX websites. More on this is in Law and regulators.

Valuation ratios describe the past and the market's current view. They are not signals and do not predict prices. Share prices can fall well below any "fair" level for long periods. If you trade index or share CFDs instead of owning shares, leverage means losses can be fast and larger than you expect. Read Risk management before putting money at risk. Wider context on combining ratios with economic data is in Fundamental analysis, and terms are defined in the Trading glossary.

Frequent questions

What is a good PE ratio?

There is no single good level. A P/E is meaningful only against the same company's history, its sector peers and the current interest rate environment.

Why is diluted EPS lower than basic EPS?

Diluted EPS counts shares that could be created from options or convertible securities. More shares in the denominator means lower EPS.

Can ROE be misleading?

Yes. Heavy borrowing, buybacks or accumulated losses shrink equity and can make ROE look high without the business being stronger.

When is the price to book ratio most useful?

For banks, insurers and asset-heavy companies, where the balance sheet reflects value reasonably well. It is much less useful for software or brand-driven companies.

Do low ratios mean a share will rise?

No. A low P/E or P/B can reflect real problems. Ratios are tools for comparison and questions, not forecasts.