12 Valuation Ratios that you should know as Investor

The world of investing can be intricate and convoluted. Wall Street gurus like to use complex algorithmic systems to determine the value of a stock price, while regular investors employ a more straightforward method. For those looking to dip their toes into the investment landscape, that method is by using valuation ratios to assess whether a company’s share price is overvalued or undervalued. 

Without further ado, let’s me introduce to you an exhaustive list of 12 valuation ratios that seasoned investors rely on for their analysis work.

Enterprise Value / Revenue

Firstly, an enterprise value is a comprehensive evaluation of a company’s value, which is measured by subtracting the company’s total cash and cash equivalents from the sum of its market value and total debts.

Analysts typically use enterprise value-to-revenue (EV/R) as an indicator to measure stock performance, which compares the enterprise value to a business’s revenue. You can also expect to see the EV/R ratio as a common metric used to evaluate a company in a merger and acquisition (M&A) deal.

Example: Suppose a fintech company currently has $60 million in total liabilities, which include both short-term and long-term debts. The company manages to store $13 million in its cash reserve, with last year’s revenue bringing in $95 million. Lastly, its outstanding common stocks are 11 million shares trading at $20 per share on the market. In this case, the EV/R can be calculated as follows:

Enterprise Value / Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA)

EV/EBITDA multiple is similar to the previous ratio in many aspects. For instance, this metric is also utilized by financial experts to determine a company’s performance, as well as for acquirers to evaluate their targets. The ratio is calculated as enterprise value divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), showing how the overall value of the company compares to its core earnings. The formula is as follows:

Example: Says this time our fintech company still has $267 million in enterprise value similar to above. But instead of using revenue, the business generated about $80 million in EBITDA last fiscal year, meaning that $80 million in earnings have not accounted for interest, taxes, depreciation, and amortization. We then have the inputs to compute the multiple. 

Enterprise Value / Earnings before Interest, and Taxes (EBIT)

Just like the previously introduced ratios, EV/EBIT is as well a multiple that is deployed to see how well a company operates compared to its market value. You might notice that it is very similar to the EV/EBITDA multiple. The difference is that this time we only exclude interest and tax expenses. This is because earnings before interest and taxes (EBIT) more accurately reflect the profitability of the company’s core operation. Furthermore, interest relates to the cost of capital when borrowing while tax rates are determined by the government, none of which stem from the business core operation. EBIT is also often known as operating income. The formula:

Example: Because now our fintech company only excludes interest and tax costs from the earnings, the earnings drop to $75 million for EBIT. With a similar enterprise value, we can calculate the multiple like so: 

Enterprise Value / Invested capital

Enterprise value-to-invested capital ratio essentially indicates how much capital invested by investors is needed to generate one dollar of enterprise value. Invested capital is the amount of money investors have poured into the business, computed as total assets minus total liabilities. The invested capital can also be understood as the book value of equity. This multiple shows how the company is valued by the market relative to the capital invested by shareholders.

Example: Again, we have our fintech business with the same enterprise value. But the company in this scenario also has $150 million in total assets and has racked up $50 million in total liabilities. This leads the company’s EV/invested capital multiple to be:

Enterprise Value / (EBITDA - CapEx)

A capital expenditure (CapEx) is investments that companies spend on things like manufacturing equipment, office supplies, or a vehicle. However, the way financial accounting works is whenever a CapEx is incurred, it will not be recorded as an expense but rather as an asset. Yet, the transaction still represents a cash outflow. 

For such reason, the EV/(EBITDA – CapEx) ratio takes into account the cash outlays for capital assets, such as buildings or computers. The multiple indicates the company’s valuation relative to its earnings before interest, taxes, depreciation, amortization, and in this case, capital expenditures too. 

Example: Suppose our fintech company is expanding its business operation, so it recently just purchased a new office building that cost around $10 million. With the same $80 million in EBITDA and $267 in enterprise value, the multiple is computed as follows:

Enterprise Value / Free Cash Flow 

While all the previous multiples mentioned so far compare company valuation with its revenue or earnings with different adjustments, those metrics don’t reflect the actual flow of cash in and out of the business entity. 

EV/FCF multiples only consider cash expenses in its free-cash-flow (FCF) denominator. That is, unlike earnings or net income, FCF does not include non-cash expenses like payables and depreciation. The metric analyzes the company’s enterprise value relative to its cash produced from operation minus any cash outflows. Acquirers can also look at this multiple to assess how quickly they can recoup their money after buying out the target. While there are several ways to calculate FCF, the following formula is one of them.

Example: Suppose the company under this example has $60 million in net income. However, the business operation also incurred annual non-cash expenses of $12 million, including amortization and deferred charges, and the same capital expenditure of $10 million like the example above. The multiple is computed by adding back the non-cash expenses and subtracting the CapEx.

Price-to-Earnings Ratio

The price-to-earnings (P/E) multiple, or earnings multiple, is arguably the most common metric deployed by investors. It has become a de facto choice to provide a quick evaluation of a company’s stock price. The ratio can be measured as price per share divided by earnings per share (EPS), or the company’s market cap divided by earnings. Analysts often use the P/E ratio to compare a stock value with its historical record or with a competitor’s stock.

Example: Pulling data from Yahoo Finance, Tesla’s trailing 12 months (TTM) earnings are $11.182 billion. The EV maker also has a market cap of $421.307 billion as of Jan. 21, 2023. You can compute the P/E ratio like the following calculation:

Price-to-Sales Ratio

In addition to the P/E ratio, price-to-sales (P/S) multiples are also useful analyses of a stock value. Instead of dividing the market cap by earnings, you put total sales or revenue in the denominator. The P/S multiple is effective in analyzing growth stocks, which represent businesses that are rapidly growing their revenue but have yet to make a profit or earnings. Similar to P/E ratios, investors rely on price-to-sales to determine whether a stock price is overvalued or undervalued. 

Example: Continuing to choose Tesla as our example, the company currently has $74.863 billion in TTM revenue. With the same market cap, the multiple can be computed as follows:

Price-to-Book Ratio

Price-to-book (P/B) multiples reflect how the market value of a company’s equity (i.e., the market cap) compares with the book value of its equity. Like the two previously introduced metrics, experts plan to use P/B to asses a stock price, whether the price is too high or too low. In other words, a high P/B ratio might suggest an overvalued stock, and a low P/B ratio might suggest the opposite. 

Example: Tesla’s balance sheet from its financial report of the quarter 03/2023 indicates the company has $41.124 billion in the book value of equity. The P/B multiple can be determined in the subsequent way:

Price-to-Tangible Book Value Ratio

You can view the price-to-tangible book (PTBV) multiple as a variation of the previous ratio. As opposed to comparing a firm’s market value with its equity book value, we make adjustments to only include the tangible net assets’ book value. These tangible assets can be machinery, raw materials, and inventories, while intangible assets involve patents, goodwill, and intellectual property. 

The PTBV ratio is employed by analysts to evaluate a company’s value against its book value of only the tangible asset. In theory, a stock’s tangible book value per share can mean the amount of money an investor would receive if a business were to liquidate all its assets. 

Example: The automaker General Motors in late 2020 had $44.44 billion in tangible book value and its per share basis was $31.74. Additionally, on the last trading day of 2020, the stock price closed at $41.64.

Price-to-Cash Flow Ratio

Price-to-cash flow (P/CF) ratio is another stock valuation indicator that compares a stock price with the company operating cash flow on a per-share basis. The P/CF multiple is effective in appraising a business that brings in positive cash flow but is yet to be profitable due to large non-cash expenses. 

Example: Suppose a pharmaceutical firm generates $400 million in operating cash flow annually with 100 million common stocks outstanding, equating to $4 per share. The company’s share price is trading at $40 per share on the market.

Price/Earnings-to-Growth Ratio

Alongside the P/E ratio, the price/earnings-to-growth (PEG) multiple is among the most commonly used metrics to evaluate a stock price. The ratio is measured by dividing the P/E ratio by the growth rate of a firm’s earnings. This PEG ratio improves upon the P/E multiple by adding projected earnings into the equation. Many investors think the PEG ratio is the most accurate indicator of a stock’s true value. 

Example: let’s use the pharmaceutical company for our last example. Says the company had an EPS of $1.74 last year but was able to increase it to $2.67 this year. Based on the earnings growth, we can deduce that the EPS gained by 20%. The stock price also has a P/E ratio of 22.

Note: when we calculate the PEG ratio, we don’t take into consideration the percentage sign for the growth value. 

Conclusion

There you have it. Those multiples comprise a comprehensive list of all the valuation ratios that Wall Street analysts and investors use to evaluate a stock's performance. Each business and industry are unique, so you should always conduct your own research and due diligence, and then decide which multiples are the most suitable metrics to assess the share price of a company.