Key Ratios (P/E, P/B, ROE, ROCE)
The most common valuation and efficiency metrics, how they are used, and where they can mislead.
Financial ratios condense complex information from financial statements into comparable, standardised metrics. They allow investors to compare companies across different sizes, sectors, and time periods. But ratios are tools, not answers. Understanding what they measure — and where they mislead — matters as much as knowing how to calculate them.
Key Concepts
Price-to-Earnings (P/E) ratio is the market price per share divided by earnings per share. It represents how many rupees investors are willing to pay for each rupee of current earnings. A P/E of 25 means the market is paying 25 times the annual earnings. Higher P/Es suggest the market expects strong future growth; lower P/Es may indicate value or declining prospects.
Price-to-Book (P/B) ratio compares market capitalisation to the net book value of assets. A P/B above 1 means the market values the company above its accounting book value — typical for profitable businesses with strong intangible assets. A P/B below 1 may indicate deep value or a fundamentally impaired business.
Return on Equity (ROE) measures how much profit a company generates per rupee of shareholder equity. A 20% ROE means the company earns ₹20 profit for every ₹100 of equity deployed. High ROE sustained over time indicates an efficient, profitable business — but can be inflated by high debt levels.
Return on Capital Employed (ROCE) measures profitability relative to all capital used (equity plus debt). It is more comprehensive than ROE because it accounts for how efficiently the total capital base (not just equity) is deployed. ROCE above the cost of capital indicates value creation; below it indicates value destruction.
Debt-to-Equity (D/E) ratio indicates financial leverage. High D/E means the company relies heavily on borrowed money. While leverage can amplify returns in good times, it significantly increases risk in downturns and constraints on future capital allocation.
Common Mistakes
Comparing ratios across different sectors without context. A P/E of 15 might be expensive for a utility and cheap for a software company. Industry norms vary enormously.
Using trailing ratios without considering the trajectory. A company reporting one-time gains might show an artificially low P/E that masks poor underlying profitability.
Relying on a single ratio to make buy or sell decisions. Ratios work as part of a framework, not in isolation.
Key Takeaways
P/E reflects how much the market pays for each unit of earnings. P/B reflects price versus book value. ROE and ROCE measure capital efficiency.
Ratios are most meaningful when compared to the company's own history, sector peers, and the broader market context.
High ratios are not automatically bad; low ratios are not automatically good. Context determines interpretation.
Use multiple ratios together to build a more complete picture of quality and valuation.