Understanding whether a stock is fairly priced can seem like a daunting task, but it doesn’t have to be.
By using a few simple valuation tools, you can gain a clearer picture of a company’s worth relative to its performance and the broader market.
Here are three key measures every stock investor should know – price-to-earnings (PE) ratio, price-to-earnings growth (PEG) ratio, and price-to-book (PB) ratio.
Investing in an individual company isn't right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
Price-to-earnings ratio
The PE ratio is one of the most widely used tools to evaluate a company’s share price compared to its earnings.
It tells you how much investors are willing to pay for every £1 of a company’s profit.
PE ratio = share price / earnings per share (EPS)
For example, if a company’s share price is £20 and it earned £2 per share in the last year, the PE ratio would be:
PE ratio = 20 / 2 = 10
This means investors are paying £10 for every £1 of earnings.
Why does it matter?
A lower PE might suggest a stock is undervalued or that its growth prospects are limited.
A higher PE can indicate the stock is expensive, investors expect strong growth in the future, or that earnings are high quality.
For example, if the average PE for similar companies is 15 and your chosen stock trades at 10, it could mean the stock is undervalued, though you’ll want to investigate why.
We prefer to use an adapted version that uses expected earnings instead of past earnings, known as the forward PE ratio.
Price-to-earnings growth ratio
The PEG ratio takes the PE ratio one step further by factoring in a company’s expected growth rate. While a stock might look expensive based on its PE, its growth prospects can sometimes justify the higher price.
PEG ratio = PE ratio / earnings growth
For example, if a company has a PE ratio of 20 but is expected to grow its earnings by 10% annually, its PEG ratio would be:
PEG ratio = 20 / 10 = 2
Why does it matter?
A PEG ratio below one is generally seen as good value, suggesting the stock is good value relative to its growth.
A PEG ratio above one means the stock might be overvalued relative to its growth rate.
The PEG ratio is particularly useful for growth stocks, where higher PE ratios are common. For instance, technology companies often trade at high PE levels, but their rapid growth can make them attractive investments when the PEG ratio is reasonable.
Price-to-book ratio
The PB ratio is another key measure that compares a company’s market value to its ‘book value’, which is essentially the net worth of its assets after liabilities.
PB ratio = share price / book value per share
For example, if a company’s book value per share is £10 and the share trades at £15, the PB ratio would be:
PB ratio = 15 / 10 = 1.5
Why does it matter?
A PB ratio below one could indicate the stock is undervalued, or that investors are wary about its prospects.
A higher PB ratio could reflect strong market confidence in the company’s future growth.
The PB ratio is particularly useful for industries like banking and manufacturing, where cash and physical assets like property and equipment play a major role. However, for companies with intangible assets – like technology companies – it might be less relevant.
This article isn't personal advice. If you're not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Ratios also shouldn't be looked at on their own and past performance isn’t a guide to the future.
How to put it all together
These three measures, PE, PEG, and PB are great tools for investors because they help simplify complex financial data.
By comparing these ratios across similar companies or sectors, you can identify whether a stock offers value, growth potential, or stability.
Start with the PE ratio for a quick sense of value.
Use the PEG ratio to account for growth prospects.
Check the PB ratio for asset heavy businesses.
Remember, no single measure tells the full story, it’s important to compare with:
The company’s historical ratios to see how its valuation has changed, we use a 10-year average.
The average valuation of competitors or the market as a whole.
Remember investing is for the long term – that’s at least five years. You should also always consider these ratios alongside other factors like the company’s overall financial health, industry trends, and broader economic conditions. By combining these tools, you’ll be better equipped to make more informed, confident investment decisions.
We’ve just released our expert share research teams’ top investment picks for 2025 and beyond.