Equity Multiples

The P/E ratio divides the stock price by earnings per share, making it the most widely quoted equity multiple. A trailing P/E uses the last twelve months of earnings while a forward P/E uses next year's consensus estimates. Higher P/E ratios generally indicate higher growth expectations or lower perceived risk. The P/E ratio is intuitive but can be distorted by capital structure differences, non-recurring items, and accounting policies.

The P/B ratio compares market capitalization to the book value of equity (total assets minus total liabilities). It is most commonly used for financial institutions like banks and insurance companies where assets and liabilities are carried near fair value. A P/B below 1.0 suggests the market values the company below its net asset value, which may indicate distress or undervaluation. Asset-light businesses like technology companies typically have very high P/B ratios because their intangible assets are not fully reflected on the balance sheet.

The PEG ratio adjusts the P/E ratio for expected earnings growth by dividing P/E by the expected EPS growth rate. A PEG of 1.0 suggests the stock is fairly valued relative to its growth rate, while below 1.0 may indicate undervaluation. The PEG ratio is useful for comparing companies with different growth rates on a more level playing field. However, it oversimplifies by assuming a linear relationship between P/E and growth, and the result depends heavily on the growth estimate used.

Equity multiples are affected by capital structure because net income and book value are post-debt metrics. Two identical companies with different leverage will have different P/E ratios even if their operations are the same. For this reason, enterprise value multiples like EV/EBITDA are generally preferred for cross-company comparisons. Equity multiples are most useful when comparing companies with similar capital structures or when valuing financial institutions where EV-based metrics are less applicable.