A $5 share can be expensive and a $900 share can be cheap, which tends to confuse everyone the first time they hear it. The share price only tells you what one slice of a company costs. It says nothing about how many slices there are, how much the business earns or how much cash it brings in. Stock valuation ratios fill that gap by comparing the price with something the company produces, and once you know the main five, a “cheap” stock gets a lot easier to judge.
Quick answer: A company is cheap when its price is low compared with what it earns or the cash it generates, measured against similar companies and its own history. The most common stock valuation ratios are P/E, forward P/E, EV/EBITDA, price-to-free-cash-flow and free-cash-flow yield, and each one answers a slightly different question.
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Why a Low Share Price Means Nothing on Its Own
Two made-up companies show how this works.
| Company A | Company B | |
|---|---|---|
| Share price | $5 | $900 |
| Shares in issue | 2 billion | 50 million |
| Market value | $10 billion | $45 billion |
| Annual profit | $250 million | $3 billion |
| Price-to-earnings ratio | 40 | 15 |
Company A’s shares look cheap at $5, but investors are paying $40 for every $1 of profit. Company B costs $900 a share and only $15 for every $1 of profit. On earnings, B is the cheaper business by a wide margin.
The same logic explains stock splits. When a company splits each share into ten, the price drops to a tenth and the value of the business stays exactly where it was.
The Five Main Stock Valuation Ratios Compared
| Ratio | How it’s worked out | What it tells you | Watch out for |
|---|---|---|---|
| P/E | Share price ÷ earnings per share | What you pay for each $1 of past profit | One-off gains and losses that distort profit |
| Forward P/E | Share price ÷ expected earnings per share | What you pay for each $1 of next year’s profit | Forecasts that turn out too optimistic |
| EV/EBITDA | Enterprise value ÷ EBITDA | Value of the whole business, debt included, against operating earnings | Ignores the cost of replacing equipment |
| Price-to-free-cash-flow | Market value ÷ free cash flow | What you pay for each $1 of cash the business keeps | Cash flow can swing year to year |
| Free-cash-flow yield | Free cash flow ÷ market value | The cash return on the price, shown as a percentage | A high yield can reflect a falling price |
P/E Ratio
The price-to-earnings ratio, explained in plain terms on the SEC’s investor education site, divides the share price by the company’s earnings per share over the last 12 months. It’s quick and widely quoted, and it’s the first number most people look at. It uses past profit, though, and one big asset sale or write-down can make a company look much cheaper or pricier than it is. Our article on the P/E ratio looks at why two companies with the same P/E can be very different investments.
Forward P/E
Forward P/E uses analysts’ estimates of next year’s earnings. If Company B is expected to earn $3.6 billion next year, its forward P/E falls to 12.5. That’s useful for growing companies, as long as you remember forecasts are opinions and they’re often revised.
EV/EBITDA
Enterprise value adds a company’s debt to its market value and subtracts its cash, giving the total cost of buying the whole business. EBITDA is earnings before interest, tax, depreciation and amortization. If Company B has $5 billion of net debt and EBITDA of $5 billion, its enterprise value is $50 billion and its EV/EBITDA is 10.
This measure is handy for comparing companies with very different amounts of debt. It skips the cost of maintaining factories, networks or fleets, which can flatter capital-heavy businesses.
Price-to-Free-Cash-Flow
Free cash flow is the cash a company has left after paying its running costs and investing in equipment, the figure you’ll find on its cash flow statement. If Company B generates $2.5 billion of free cash flow, its price-to-free-cash-flow is 18. Cash is much harder to dress up than accounting profit, and our article on free cash flow vs net profit shows why the two can drift apart.
Free-Cash-Flow Yield
This flips the last ratio upside down. Company B’s $2.5 billion of free cash flow on a $45 billion market value gives a free-cash-flow yield of about 5.6%. Showing it as a percentage makes it easy to compare with other returns, including government bonds.
Compare Valuation Ratios Like With Like
A valuation ratio only means something when it’s measured against the right benchmark.
- Against similar companies: software firms often trade on higher multiples than utilities or banks, because investors expect faster growth
- Against the company’s own history: a stock trading well under its usual P/E may be good value, or it may be telling you something has changed
- Against interest rates: with the 10-year US Treasury yield above 5% in October 2026, a free-cash-flow yield of 4% looks a lot less appealing than it did when bonds paid 1%, as our article on bond yields and stocks explains
When a Low Valuation Is a Warning
Some stocks look cheap because the market expects their earnings to fall. A newspaper publisher on a P/E of 6 might be a bargain, or its advertising revenue might be shrinking every year. That’s the difference between a cheap stock and a value trap, and our guide to spotting value traps goes through what to check.
A Quick Stock Valuation Checklist
- Check at least two ratios, ideally one based on earnings and one based on cash
- Compare them with close competitors in the same industry
- Look at how the ratios have moved over the last five years
- Read the latest earnings report for one-off items that distort profit
- Check debt levels before trusting a low P/E
Frequently Asked Questions
What is a good P/E ratio?
There’s no single good P/E ratio, because it depends on the industry and how fast a company is growing. Mature businesses like utilities often trade between 10 and 20 times earnings, while fast-growing tech companies can sit well above 30. A P/E is most useful when compared with similar companies and the company’s own history.
What is the difference between P/E and forward P/E?
P/E divides the share price by earnings over the past 12 months, while forward P/E uses analysts’ forecasts for the next 12 months. Forward P/E is useful for growing companies whose profits are rising quickly, but it depends on estimates that can change. Comparing the two shows how much growth the market expects.
Is EV/EBITDA better than P/E?
Each ratio is better for a different job. EV/EBITDA includes debt and leaves out interest, tax and depreciation, which makes it useful for comparing companies with different amounts of borrowing. P/E is simpler and more widely quoted. Many investors look at both before deciding if a stock is good value.
What is a good free cash flow yield?
A free cash flow yield above the yield on government bonds is often seen as a sign of good value, since the company produces more cash than a risk-free investment pays. With US 10-year Treasuries above 5% in October 2026, that bar is higher than usual, and the right level also depends on the company’s growth and risk.
