When investors try to evaluate a stock, the first two ratios they usually hear about are PE Ratio and PB Ratio.
But many beginners get confused:
> Which ratio is more important ?
> Should we use PE or PB ?
In this article, we will explain PE Ratio vs PB Ratio in simple words, with examples, advantages, limitations, and when to use each ratio.
What is PE Ratio ?
The Price-to-Earnings (P/E) ratio is a common financial metric used to evaluate a company’s stock value by comparing its current share price to its earnings per share (EPS). It helps investors gauge if a stock is potentially overvalued, undervalued, or fairly priced relative to its profits. A high P/E ratio often suggests high investor expectations for future earnings growth, while a low P/E might indicate lower growth prospects or potential undervaluation.
PE Ratio (Price to Earnings Ratio) shows how much investors are willing to pay for ₹1 of company’s earnings.
Formula:PE Ratio = Market Price per Share ÷ Earnings Per Share (EPS)
Example:
Share price = ₹100
EPS = ₹10
PE Ratio = 200 ÷ 20 = 10
This means investors are paying ₹10 for every ₹1 profit the company earns.
What Does PE Ratio Indicate ?
High PE → Market expects high future growth
Low PE → Stock may be undervalued or company growth is slow
Advantages of PE Ratio
> Very easy to understand
> Best for profit-making companies
> Widely used in stock market analysis
> Helpful for growth stock comparison
> Simplicity and Ease of Use
> Indicates Market Expectations
Limitations of PE Ratio
> Not useful if company is loss-making
> EPS can be manipulated through accounting
> High PE does not always mean good stock
> Should not be used alone
> Ignores Debt and Cash Flow
> Problematic for Cross-Industry Comparisons
What is PB Ratio ?
The Price-to-Book (P/B) ratio is a financial metric that compares a company’s market price per share to its book value per share. It is a valuation tool used by investors, particularly value investors, to assess whether a stock is overvalued or undervalued relative to its net assets.
PB Ratio (Price to Book Value Ratio) compares a company’s market price with its book value (net assets).Formula:PB Ratio = Market Price per Share ÷ Book Value per Share
Example:Share price = ₹200
Book value per share = ₹100
PB Ratio = 200 ÷ 100 = 2
This means stock is trading at 2 times its book value.
What Does PB Ratio Indicate ?
PB < 1 → Stock may be undervalued
PB > 1 → Market is valuing company higher than assets
Advantages of PB Ratio
> Very useful for banking & PSU stocks
> Best for asset-heavy companies
> Not affected by short-term profit changes
> Helpful during market downturns
> Assesses Financial Health & Solvency
> Useful for Distressed Companies
> Provides a Margin of Safety
Limitations of PB Ratio
> Not suitable for IT or service companies
> Ignores future growth potential
> Book value may not reflect true asset value
> Ignores Intangible Assets
> Does Not Reflect Market Value of Assets
Which Ratio is Better – PE or PB ?
There is no single “best” ratio, PE Ratio is better for earnings-driven businesses while PB Ratio is better for asset-driven businesses, Smart investors use both together, along with: ROE, ROCE, Debt levels, Cash flow, Share Holding Pattern, Promoter Pledge Percentage, Revenue Guidance
Common Mistake Investors Make
> Buying stock only because PE or PB is low
> Comparing ratios across different sectors
> Ignoring business quality & management
Always remember:Valuation ratios support decision – they don’t make decision alone.
Always keep in mind low valuation does not mean good investment, and high valuation does not mean bad investment.
