PE, PB, PS—confusing these ratios? A comprehensive guide to understanding the meaning of Price-to-Earnings, Price-to-Book, and Price-to-Sales ratios in English and their practical applications

Why Understanding the Price-to-Earnings Ratio (PE/PER) Is Essential for Stock Investment

In stock investing, the Price-to-Earnings Ratio (PE/PER) is the primary metric for evaluating a stock’s value. Whether you’re a professional advisor or a retail investor, this number is indispensable—it directly tells you whether the current stock price is cheap or expensive and whether it’s worth buying.

The core logic of the PE ratio is simple: it reflects how many years it would take to earn back the investment at the current earnings. This indicator is easy to understand and sufficiently scientific, making it a universal valuation tool for investors worldwide.

Full Name and Calculation Logic of the PE Ratio

The full English name of PE ratio is Price-to-Earnings Ratio, abbreviated as PE or PER. In Chinese, it’s also called “市盈率,” which refers to the same concept.

Calculating the PE ratio requires a simple formula: Stock Price ÷ Earnings Per Share (EPS) = PE Ratio

Alternatively, at the company level: Market Capitalization ÷ Net Profit Attributable to Common Shareholders = PE Ratio

We usually use the first method. For example, if a company’s stock price is 100 yuan and its EPS in 2023 is 10 yuan, then the PE ratio is 100 ÷ 10 = 10. What does this 10 represent? It indicates that, at the current profit level, it would take 10 years to earn back the current market value of the stock.

Three Types of PE Ratios and Their Application Scenarios

Depending on the EPS data used, PE ratios are mainly divided into three types. Understanding their differences helps you evaluate stocks more accurately.

First: Static PE (Historical PE)

This is calculated using the annual EPS of the past year, with the formula: Stock Price ÷ Annual EPS. The data is relatively stable, but the drawback is slow responsiveness and potential lag. For example, if last year’s annual report shows EPS of 15 yuan, and this year’s stock price has already increased by 50%, then using last year’s EPS to calculate the PE ratio is no longer accurate.

Second: Trailing PE (TTM PE)

This uses the total EPS of the most recent 12 months, also called “Trailing Twelve Months” (TTM). The formula is: Stock Price ÷ Sum of EPS over the last 4 quarters. Since listed companies release quarterly reports, this method effectively uses the latest four quarters’ data. It is more timely than static PE and better reflects recent company performance.

Third: Forward PE (Estimated PE)

This uses analyst or institutional forecasts of future EPS, with the formula: Stock Price ÷ Estimated Annual EPS. While it aims to reflect future prospects, the problem is that different analysts’ estimates vary, and they often overestimate or underestimate, making this metric less reliable.

For comparison, you can think of it this way: static PE is the most conservative but lagging, trailing PE balances timeliness and accuracy, and forward PE is the most forward-looking but least reliable.

How to Judge Whether a PE Ratio Is High or Low

When you see a PE number, the key is to have a reference for comparison. There are two common methods.

Compare with Industry Peers

PE ratios vary greatly across industries. For example, emerging tech companies might have PE ratios as high as 50, while mature manufacturing firms might only have 8. This doesn’t mean the mature industry is cheap; it’s just due to industry characteristics. The meaningful comparison is within the same industry, using similar competitors.

For example, suppose in the chip manufacturing sector, Company A has a PE of 13, Company B has 8, and Company C has 47. Compared to B, Company A is in the middle—neither overvalued nor undervalued.

Compare with Historical Trends

Look at the current PE relative to the company’s past PE trends to determine if it’s at a high or low point historically. If the current PE is below 90% of the past five years’ levels, it suggests the stock is relatively cheap; if above 95%, it might be expensive. This method is simple and effective, suitable for long-term investors.

Practical Value of the PE River Chart

The PE river chart is a visualization tool that intuitively shows where the stock price stands within its historical valuation range.

The principle is: Stock Price = EPS × PE. By plotting horizontal lines representing the historical maximum, minimum, and median PE levels, a “river” shape forms. The current stock price’s position within this river indicates whether it’s overvalued or undervalued.

If the stock price is below the river, it suggests undervaluation and potentially a good buying opportunity. However, note that undervaluation does not guarantee a rise, as many factors influence stock prices; PE is just one reference.

Three Major Limitations of the PE Ratio

Although PE is useful, investors must be aware of its shortcomings.

Limitation 1: Ignores Company Debt

PE considers only profit, not debt levels. Two companies with the same EPS can have vastly different risk profiles—one financed mainly by equity, the other heavily leveraged. During economic downturns or rising interest rates, high-debt companies face greater risks. Therefore, PE comparison should be supplemented with debt analysis.

Limitation 2: Difficult to Define High or Low

A high PE does not necessarily indicate a bubble. Sometimes, a high PE results from temporary poor performance, with strong fundamentals intact, and the market still prices it at a premium; other times, it reflects high growth potential priced in advance. These situations require detailed analysis rather than mechanical judgment.

Limitation 3: Cannot Evaluate Non-Profit Companies

Startups and biotech firms often operate at losses, making PE impossible to calculate. In such cases, other metrics like Price-to-Book (PB) or Price-to-Sales (PS) are used.

Choosing and Applying PE, PB, and PS

These three metrics each have their focus and are suitable for different types of companies.

PE (Price-to-Earnings Ratio): Suitable for Stable Profitability Companies: Calculated as Stock Price ÷ EPS. Higher values indicate higher valuation. Best for mature, predictable profit companies.

PB (Price-to-Book Ratio): Suitable for Cyclical Companies: Calculated as Stock Price ÷ Book Value per Share. When PB < 1, it indicates the stock is trading below its net asset value (a potential undervaluation); PB > 1 suggests the opposite. Commonly used for banks, real estate, and cyclical stocks.

PS (Price-to-Sales Ratio): Suitable for Unprofitable Companies: Calculated as Stock Price ÷ Revenue per Share. Higher values mean higher valuation. Especially useful for emerging industries and startups without stable profits.

These three indicators complement each other. Smart investors choose the most appropriate tool based on the company’s characteristics: stable profits for PE, cyclical industries for PB, and unprofitable startups for PS. Mastering this logic will make your stock selection process much clearer.