The 4 Basic Elements of Stock Value (2024)

Investing has a set of four basic elements that investors use to break down a stock's value. In this article, we will look at four commonly used financial ratios—price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, price-to-earnings growth (PEG) ratio, and dividend yield—and what they can tell you about a stock. Financial ratios are powerful tools to help summarize financial statements and the health of a company or enterprise.

Key Takeaways

  • Financial statements can be used by analysts and investors to compute financial ratios that indicate the health or value of a company and its shares.
  • P/E, P/B, PEG, and dividend yields are four commonly used metrics that can help break down a stock's value and outlook.
  • Any single ratio is too narrowly focused to stand alone, so combining these and other financial ratios gives a more complete picture.

1. Price-to-Book (P/B) Ratio

Made for glass-half-empty people, the price-to-book (P/B) ratio represents the value of the company if it is torn up and sold today. This is useful to know because many companies in mature industries falter in terms of growth, but they can still be a good value based on their assets. The book value usually includes equipment, buildings, land, and anything else that can be sold, including stock holdings and bonds.

With purely financial firms, the book value can fluctuate with the market as these stocks tend to have a portfolio of assets that goes up and down in value. Industrial companies tend to have a book value based more on physical assets, which depreciate year over year according to accounting rules.

In either case, a low P/B ratio can protect you—but only if it's accurate. This means an investor has to look deeper into the actual assets making up the ratio.

2. Price-to-Earnings (P/E) Ratio

The price to earnings (P/E) ratio is possibly the most scrutinized of all the ratios. If sudden increases in a stock's price are the sizzle, then the P/E ratio is the steak. A stock can go up in value without significant earnings increases, but the P/E ratio is what decides if it can stay up. Without earnings to back up the price, a stock will eventually fall back down. An important point to note is that one should only compare P/E ratios among companies in similar industries and markets.

The reason for this is simple: A P/E ratio can be thought of as how long a stock will take to pay back your investment if there is no change in the business. A stock trading at $20 per share with earnings of $2 per share has a P/E ratio of 10, which is sometimes seen as meaning that you'll make your money back in 10 years if nothing changes.

The reason stocks tend to have high P/E ratios is that investors try to predict which stocks will enjoy progressively larger earnings. An investor may buy a stock with a P/E ratio of 30 if they think it will double its earnings every year (shortening the payoff period significantly). If this fails to happen, the stock will fall back down to a more reasonable P/E ratio. If the stock does manage to double earnings, then it will likely continue to trade at a high P/E ratio.

3. Price-to-Earnings Growth (PEG) Ratio

Because the P/E ratio isn't enough in and of itself, many investors use the price to earnings growth (PEG) ratio. Instead of merely looking at the price and earnings, the PEG ratio incorporates the historical growth rate of the company's earnings. This ratio also tells you how company A's stock stacks up against company B's stock. The PEG ratio is calculated by taking the P/E ratio of a company and dividing it by the year-over-year growth rate of its earnings. The lower the value of your PEG ratio, the better the deal you're getting for the stock's future estimated earnings.

By comparing two stocks using the PEG, you can see how much you're paying for growth in each case. A PEG of 1 means you're breaking even if growth continues as it has in the past. A PEG of 2 means you're paying twice as much for projected growth when compared to a stock with a PEG of 1. This is speculative because there is no guarantee that growth will continue as it has in the past.

The P/E ratio is a snapshot of where a company is and the PEG ratio is a graph plotting where it has been.Armed with this information, an investor has to decide whether it is likely to continue in that direction.

4. Dividend Yield

It's always nice to have a backup when a stock's growth falters. This is why dividend-paying stocks are attractive to many investors—even when prices drop, you get a paycheck. The dividend yield shows how much of a payday you're getting for your money. By dividing the stock's annual dividend by the stock's price, you get a percentage. You can think of that percentage as the interest on your money, with the additional chance at growth through the appreciation of the stock.

Although simple on paper, there are some things to watch for with the dividend yield. Inconsistent dividends or suspended payments in the past mean that the dividend yield can't be counted on. Like water, dividends can ebb and flow, so knowing which way the tide is going —like whether dividend payments have increased year over year—is essential to making the decision to buy. Dividends also vary by industry, with utilities and some banks typically paying a lot whereas tech firms, which often invest almost all their earnings back into the company to fuel growth, paying very little or no dividends.

What Is a Good P/B Ratio?

What is considered a “good” or "bad" P/B ratio depends on the industry in which the company is operating and the overall state of valuations in the market. Generally speaking, a P/B ratio under 1.0 is considered optimal since it indicates that an undervalued stock may have been identified. However, some investors assessing the P/B value of a stock may choose to accept a higher P/B ratio of up to 3.0.

What Is a Good P/E Ratio?

Again, this depends on the industry of the company in question, but, as rule of thumb, the lower the P/E is, the better. A good P/E ratio should also be lower than the average P/E ratio, which is between 20–25.

What Is a Good PEG Ratio?

In general, a PEG ratio is considered to be good when it has a value lower than 1.0, suggesting a stock is relatively undervalued.

The Bottom Line

The P/E ratio, P/B ratio, PEG ratio, and dividend yields are too narrowly focused to stand alone as a single measure of a stock. By combining methods of valuation, you can get a better view of a stock's worth. Any one of these can be influenced by creative accounting—as can more complex ratios like cash flow.

As you add more tools to your valuation methods, discrepancies get easier to spot. These four main ratios may be overshadowed by thousands of customized metrics, but they will always be useful stepping stones for finding out whether a stock is worth buying.

I am an expert and enthusiast assistant. I have access to a wide range of information and can provide insights on various topics. I can help you with your questions about investing and the four basic elements used to analyze a stock's value: the price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, price-to-earnings growth (PEG) ratio, and dividend yield.

Let's dive into each of these concepts and explore what they can tell you about a stock.

Price-to-Book (P/B) Ratio

The price-to-book (P/B) ratio is a financial ratio that represents the value of a company if it were to be torn up and sold today. It is useful for assessing the value of companies in mature industries that may not be experiencing significant growth but still have valuable assets. The book value includes physical assets like equipment, buildings, land, as well as stock holdings and bonds. The P/B ratio can vary depending on the type of company, with financial firms' book value fluctuating with the market and industrial companies' book value based more on physical assets that depreciate over time.

Price-to-Earnings (P/E) Ratio

The price-to-earnings (P/E) ratio is one of the most scrutinized financial ratios. It compares a company's stock price to its earnings per share (EPS). The P/E ratio helps investors assess how long it would take for their investment to be paid back based on the company's current earnings. A lower P/E ratio generally indicates that the stock is relatively undervalued, while a higher P/E ratio suggests that investors have higher expectations for future earnings growth. It's important to compare P/E ratios among companies in similar industries and markets to get a meaningful comparison.

Price-to-Earnings Growth (PEG) Ratio

The price-to-earnings growth (PEG) ratio is a variation of the P/E ratio that incorporates the historical growth rate of a company's earnings. It provides a more comprehensive view of a stock's value by considering both its price and earnings growth. The PEG ratio is calculated by dividing the P/E ratio by the company's year-over-year earnings growth rate. A lower PEG ratio indicates a better deal in terms of the stock's future estimated earnings. It allows investors to compare the relative value of two stocks and assess how much they are paying for growth.

Dividend Yield

Dividend yield is a financial ratio that shows the percentage return an investor receives from owning a stock in the form of dividends. Dividend-paying stocks are attractive to many investors because they provide a regular income stream, even when stock prices may be volatile. Dividend yield is calculated by dividing the annual dividend per share by the stock's price. It's important to note that dividend payments can vary by industry, with some industries, like utilities and banks, typically paying higher dividends compared to industries like technology that may reinvest earnings for growth. Investors should also consider the consistency and history of dividend payments when evaluating dividend yield.

Remember, these financial ratios are powerful tools for assessing a stock's value and outlook. However, it's important to consider them in combination with other financial ratios and factors to get a more complete picture of a company's financial health and potential for growth.

Let me know if there's anything else I can help you with!

The 4 Basic Elements of Stock Value (2024)


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