What you will learn
- Calculate valuation ratios with compatible units.
- Identify why a lower ratio does not establish lower risk.
Price-to-Earnings Ratio (P/E)
A trailing P/E uses earnings from the past twelve months; a forward P/E uses estimates, which are uncertain. A higher P/E generally reflects expectations of faster growth or lower risk, while a lower P/E may reflect slower growth, higher risk or temporarily high profits.
P/E works best for comparing similar companies with positive, stable earnings. When earnings are negative the ratio has no useful meaning, and when they are close to zero it becomes extremely large, so data providers usually show it as not meaningful.
Price-to-Book Ratio (P/B)
Book value per share is shareholders' equity divided by shares outstanding. A P/B above 1 means the market values the company above its recorded net assets, often because it expects strong returns on them; a P/B below 1 means the price is under book value, which may signal doubts about asset quality, weak profitability or temporary pessimism.
P/B is most informative for asset-heavy businesses such as banks, insurers and property companies. It says less about firms whose value lies in brands, software or people, because many internally built intangibles are not on the balance sheet.
Market Capitalization
Market cap moves whenever the share price moves. Because the price is multiplied by every share in issue, a stock with a high price per share is not necessarily a large company: a HK$5 stock with many shares can be bigger than a HK$500 stock with few.
Investors group companies into large-, mid- and small-cap bands, but the cut-offs differ by market and data provider. Market cap is also the starting point for cap-weighted indexes. It ignores debt and cash, so it is not the same as enterprise value or the price needed to acquire the whole company.
Worked example: Two ratios, different questions
Illustrative: a fictional share price of HK$30, annual EPS of HK$3 and book value of HK$20 per share produce a P/E of 10 and a P/B of 1.5. Another company may have lower ratios because its earnings are temporary or its assets are impaired. Ratios describe a relationship to accounting figures, not a stand-alone conclusion about future returns.
Check your understanding
A share is HK$24 and annual EPS is HK$2. What is P/E, and what happens if EPS is negative?
Show answer and explanation
P/E = 24 ÷ 2 = 12. With negative earnings, a mechanical negative ratio is not a meaningful cheapness ranking; examine the loss and the relevant accounting context instead.