How to use price multiple ratios to evaluate stocks?

For stock valuation, we use various price multiples like P/E, P/B and P/S. These ratios are quite interesting and knowing which price multiple to use when is very important.

A widely used price multiple for stock valuation is P/E ratio. P/E ratio shows that how much money you are ready to pay for one rupee of the company's earnings. It must be used for the companies which are into similar type of business. If the companies are from different industries, one should not use P/E ratio to compare them.

P/E Ratio= Market price per share/EPS

Another valuation measure is P/B ratio i.e. Price to book value ratio. It compares the company's market price with its book value. Generally, P/B of less than 1 is preferred but it can vary from industry to industry. Overall, we can say lower the P/B, better is the stock considering the overall industry scenario. Mostly, P/B is used in evaluating banking and NBFCs stocks.

P/B Ratio= Market Cap/Book value

With regards to the P/S ratio, that is, price to sales ratio, it shows how much an investor has paid for the sales generated per share. Generally, lower P/S is positive and good when compared to the overall industry scenario and can vary from industry to industry. We can use P/S for the companies who deliver negative profits.

P/S Ratio= Market price per share/sales per share.

Now that you are armed with this knowledge, whenever you are checking out stocks for investment, rank your selection using these ratios. Happy Investing!