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A high P/E is not a verdict of "expensive." It is a sentence the market is speaking about the future, and learning to read that sentence is where valuation actually begins.
Relative valuation prices a company by comparing it to similar companies or recent transactions.
Some companies operate multiple, very different businesses, a conglomerate might own a cement plant, a hospitality chain, and a financial services arm.
Market ratios combine financial statement data with market prices to express what investors are paying for each unit of earnings, book value, or cash flow.
Market capitalisation is the total market value of all of a company's shares. It is the money you would need to buy 100 percent of the company at today's share price.
Enterprise value is the true cost of acquiring the whole business. It adds the debt you would inherit to the market cap and subtracts the cash you would gain.
Earnings per share is the slice of net profit that belongs to each share. It is the building block for the PE and PEG ratios.
The PE ratio tells you how many years of current earnings you are paying for a share. It is the most used, and most misused, valuation ratio.
The price to book ratio compares the share price with the book value per share, the accounting net worth that backs each share.
The PEG ratio adjusts the PE ratio for profit growth. It asks whether the multiple you are paying is justified by how fast earnings are growing.
The price to cash flow ratio compares the share price with operating cash flow per share. It uses money actually received instead of booked profit.
The price to sales ratio compares a company's market cap with its annual revenue. It is the multiple you fall back on when there are no earnings to divide by.
EV to EBITDA compares the total cost of acquiring a business, debt included, with its operating earnings before interest, tax, depreciation, and amortisation.
EV to sales compares the total cost of acquiring a business with its annual revenue. It is the price to sales ratio corrected for debt and cash.
Earnings yield is the PE ratio turned upside down: the profit a company earns per year as a percentage of its share price. It lets you compare a stock directly with a bond or a fixed deposit.
Free cash flow yield is the surplus cash a business generates in a year as a percentage of its market cap. It is the earnings yield computed on cash that actually exists.
Dividend yield is the cash dividend paid per share as a percentage of the current share price. It is the only dividend figure worth looking at; the dividend percentage quoted on face value is meaningless.
Related topics: Valuation, DCF, Cost of Capital, Financial Statements, Cash Flow, Earnings Quality, Red Flags, Ratios
