What P/E and P/B Ratios Tell You
The Price-to-Earnings (P/E) ratio — price ÷ EPS — shows how many years of current earnings you're paying for when you buy a share. A P/E of 15 means you're paying 15 times the company's annual earnings. Lower generally means cheaper relative to profits, though "cheap" always needs context.
The Price-to-Book (P/B) ratio — price ÷ book value per share — compares the market price to the company's net asset value on the balance sheet. A P/B below 1 means the stock trades below its accounting net worth, historically a hallmark of classic Graham-style deep value investing.
Traditional Value Investing Benchmarks
Benjamin Graham's classic guidelines suggested looking for a P/E below 15 and a P/B below 1.5 (and specifically, P/E × P/B below 22.5 — the basis of the Graham Number). These thresholds originated in the mid-20th century and should be treated as a historical reference point, not a hard rule — average market P/E levels vary significantly across different interest rate environments and decades.
Why Industry Context Matters
A "good" P/E or P/B varies enormously by industry. Capital-intensive businesses like banks and utilities often trade at low P/B ratios because their book value (physical assets, loan portfolios) is large relative to earnings. Asset-light software or services businesses routinely trade at high P/B because their real value — brand, customer relationships, intellectual property — often isn't fully reflected on the balance sheet. Comparing a company's ratios only to its own history and to close industry peers gives far more useful signal than comparing across unrelated sectors.
Worked Example
A share trades at 24.00. The company earned 2.00 per share last year and has a book value of 16.00 per share. The P/E ratio is 24 ÷ 2 = 12, so you are paying twelve years of current earnings. The P/B ratio is 24 ÷ 16 = 1.5, so you are paying one and a half times the company's net assets. The product is 12 × 1.5 = 18, comfortably below Graham's limit of 22.5.
The inverse of the P/E ratio is the earnings yield: 1 ÷ 12 ≈ 8.3%. It is a useful way to compare a share with a bond or a savings account. If a government bond pays 3% and a stable company has an earnings yield of 8%, the share offers more earnings for every euro, dollar or pound invested, although with more risk.
How to Use the Ratios Well
- Compare a company with its own history. A P/E far below the company's ten-year average can signal an opportunity, or a problem.
- Compare with close competitors in the same industry, not with the whole market.
- For cyclical companies, use average earnings over a full cycle. At the top of a cycle profits are high and the P/E looks deceptively low.
- Treat the ratios as a first screen. They tell you where to look, not what to buy. A full estimate of value needs a method such as the DCF Calculator.
Frequently Asked Questions
What does a negative P/E mean?
A negative P/E occurs when a company has negative earnings (a net loss). In this case the ratio is not meaningful — investors typically look at other metrics such as price-to-sales for unprofitable companies.
Is a low P/B always a bargain?
Not necessarily — a persistently low P/B can also signal a value trap, where the market correctly anticipates declining future profitability or asset write-downs. Always investigate why a ratio looks cheap before assuming it's an opportunity.
Should I use trailing or forward earnings for P/E?
Both are used in practice. Trailing P/E (based on the last 12 reported months) is more objective since it uses actual results. Forward P/E (based on analyst estimates) can better reflect a business's current trajectory but relies on forecasts that may prove wrong.
