Price Ratios

Price Ratios

Price ratios are used to get an idea of whether a stock's price is reasonable or not. They are easy to use and generally pretty intuitive, but do not forget this major caveat: Price ratios are "relative" metrics, meaning they are useful only when comparing one company's ratio to another company's ratio, a company's ratio to itself over time, or a company's ratio to a benchmark. 

1) Price-to-Earnings Ratio (P/E) 

What you need:     Income Statement, Most Recent Stock Price

The formula:         P/E Ratio = Price per Share / Earnings Per Share

What it means:     Think of the price-to-earnings ratio as the price you'll pay for $1 of earnings. A very, very general rule of thumb is that shares trading at a "low" P/E are a value, though the definition of "low" varies from industry to industry. 

[InvestingAnswers Feature: The P/E Ratio -- A True Measure of Profits?]

2) PEG Ratio

What you need:     Income Statement, Most Recent Stock Price

The formula:         PEG Ratio = (P/E Ratio) / Projected Annual Growth in Earnings per Share 

What it means:      The PEG ratio uses the basic format of the P/E ratio for a numerator and then divides by the potential growth for EPS, which you'll have to estimate. The two ratios may seem to be very similar but the PEG ratio is able to take into account future earnings growth. A very generally rule of thumb is that any PEG ratio below 1.0 is considered to be a good value.

3) Price-to-Sales Ratio

What you need:     Income Statement, Most Recent Stock Price

The formula:         Price-to-Sales Ratio = Price per Share / Annual Sales Per Share

What it means:      Much like P/E or P/B, think of P/S as the price you'll pay for $1 of sales. If you are comparing two different firms and you see that one firm's P/S ratio is 2x and the other is 4x, it makes sense to figure out why investors are willing to pay more for the company with a P/S of 4x. The P/S ratio is a great tool because sales figures are considered to be...