Whether a stock is “expensive” or “cheap” isn’t decided by its price – a €500 stock can be cheap, a €5 stock wildly overpriced. What matters is how much earnings, revenue or cash flow you get for your money. That is exactly what valuation ratios measure. This guide explains the four most important ones – P/E, PEG, P/S and EV/EBITDA – with formula, worked example and, above all, the situations in which each of them can mislead you.
Comparing EV/EBITDA: what matters
EV/EBITDA relates enterprise value (market capitalization plus net debt) to operating earnings before depreciation and amortization. Unlike the P/E ratio, it takes debt into account, which makes it especially suitable for comparing companies with different levels of debt. But the comparison only makes sense within the same industry and against the company’s own history: a software group and a utility have structurally very different values. For banks and insurers, EV/EBITDA doesn’t fit at all; there you use the P/E ratio and price-to-book.
The principle: price divided by an earnings measure
All four ratios follow the same pattern: you divide the price (share price or enterprise value) by an earnings measure (earnings, revenue, EBITDA). The result is a multiple – “you pay X times Y.” The multiple on its own says nothing; it only becomes meaningful in comparison: with the industry, with the company’s own history and with expected growth. If you skip this three-way comparison, you’re reading numbers without meaning.
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Analyze a stockP/E ratio: the classic – and its cyclical trap
Formula in words: share price divided by earnings per share. Alternatively: market capitalization divided by annual net income – same result.
Worked example: A share costs €60, and the company earns €3 per share. P/E = 60 ÷ 3 = 20. So you pay 20 times annual earnings; if earnings stayed constant and all flowed to you, you would mathematically recoup your investment after 20 years. Read the other way around: 1 ÷ 20 = 5% “earnings yield” per year.
When it works: For profitable companies with reasonably stable earnings – consumer goods, software, insurers. Here the P/E ratio is the quickest valuation anchor and comparable over decades.
When it misleads: The classic trap is cyclical stocks – carmakers, chemicals, steel, semiconductors. At the earnings peak of the cycle, profits explode, the P/E falls to a seemingly dirt-cheap 4 to 6 – and that is often exactly when the stock is most dangerous, because the next downturn halves or wipes out earnings. In a downturn, the opposite happens: earnings collapse, the P/E shoots up to 40 or becomes impossible to calculate for lack of profit – precisely when the stock may be historically cheap. Rule of thumb: with cyclicals, a low-looking P/E is a warning sign, not a buy signal. Second trap: one-off effects such as sales of stakes inflate a single year’s earnings and artificially depress the P/E – so always check whether earnings are “clean.”
PEG: P/E relative to growth
Formula in words: P/E ratio divided by expected annual earnings growth in percentage points.
Worked example: A software company has a P/E of 30 and is expected to grow 25% per year. PEG = 30 ÷ 25 = 1.2. A consumer goods group with a P/E of 22 and 5% growth comes to a PEG of 4.4. As a rough rule of thumb, a PEG around 1 is considered fair and significantly above that demanding – which explains why the higher-looking P/E of 30 can be the more relaxed valuation here.
When it works: Exactly for this case – making growth companies comparable that always look “too expensive” on a raw P/E. The PEG answers the question: how much valuation am I paying per percentage point of growth?
When it misleads: The PEG stands or falls with the growth estimate – and that is a forecast, not a fact. If you assume 25% growth for five years where only two are realistic, you can make any stock look good. The ratio also fails for slow growers (2% growth produces absurd values) and completely ignores debt and the quality of growth: 20% growth with shrinking margins and capital increases is worth less than 12% achieved organically.
P/S ratio: when there are no profits (yet)
Formula in words: market capitalization divided by annual revenue.
Worked example: A company is worth €5 billion on the stock market and generates €2 billion in revenue. P/S = 5 ÷ 2 = 2.5. You pay 2.5 times annual revenue.
When it works: For unprofitable growth companies, for which a P/E simply doesn’t exist for lack of profit – young tech and biotech companies, turnaround cases. Revenue is also harder to manipulate than earnings, which makes the P/S ratio robust against accounting cosmetics.
When it misleads: The P/S ratio ignores margins – and with them half the business model. A software provider with an 80% gross margin may be worth a P/S of 8, while a grocery retailer with a 2% net margin is already richly valued at a P/S of 1: one euro of revenue might turn into 25 cents of profit for one, and 2 cents for the other. P/S comparisons across industries are therefore worthless. And for permanently unprofitable companies: a low P/S doesn’t turn a business with no path to profitability into a bargain – revenue that never becomes profit is worth little to shareholders.
EV/EBITDA: the ratio that makes debt visible
Formula in words: enterprise value (market capitalization plus net debt) divided by EBITDA, earnings before interest, taxes, depreciation and amortization.
Worked example: Market capitalization €10 billion, net debt €4 billion → enterprise value €14 billion. With €2 billion EBITDA, that gives EV/EBITDA = 14 ÷ 2 = 7. The key point: a debt-free company with the same market capitalization and the same EBITDA would come to 10 ÷ 2 = 5 – and would be significantly cheaper despite an identical “price tag” on the stock market. The P/E ratio would largely swallow this difference.
When it works: Whenever debt plays a role – telecoms, utilities, real estate, private equity targets – and when comparing companies with different capital structures, tax rates or depreciation policies. That’s why it’s the standard metric in acquisitions: after all, the buyer also takes on the debt.
When it misleads: EBITDA pretends that depreciation isn’t a real expense. In capital-intensive businesses – machinery, airlines, networks – it is very real, though: the machines have to be replaced at some point. A “cheap” EV/EBITDA of 5 can then correspond to a very expensive ratio to free cash flow. That’s why Charlie Munger polemically called EBITDA “bullshit earnings.” Rule of thumb: never read EV/EBITDA without looking at capital expenditure needs and free cash flow.
Industry comparison and own history: the double benchmark
Each of these ratios needs two axes of comparison. First, the industry: software is structurally valued higher than steel because margins, capital requirements and growth differ – a P/E of 25 can be normal for a software provider and absurd for a steel group. So always compare with direct competitors. Second, the company’s own history: if a stock trades at 30 times earnings while it averaged 20 times over the past ten years, you’re paying a 50% premium – which is only justified if the business has measurably improved (more growth, better margins, a stronger moat, as is characteristic of quality stocks). If it hasn’t, you’re merely buying higher expectations.
Why no single ratio is enough
Every multiple highlights one facet and hides others: the P/E ignores debt and growth, the PEG depends on a forecast, the P/S ignores margins, EV/EBITDA ignores capital expenditure needs. Only together do they form a picture – and only in the context of business model, balance sheet and risk does the picture become a judgment. The guide Learning stock analysis shows how this assessment works step by step; if you want to go from multiples to intrinsic value, the article on fair value via DCF picks up from here. Further ratios, from payout ratio to interest coverage, are explained in the glossary.
In practice, this means: check several ratios in parallel, benchmark each against industry and history, and keep the weaknesses of each ratio in mind. Incidentally, the AI analysis from aktienanalyse.ai works on exactly this principle – it condenses more than 35 fundamental metrics into a score and a fair value range instead of relying on a single multiple. Whether you build the bundle by hand or get it as a structured summary: what matters is that you never trust a single number.
Conclusion: multiples are thermometers, not a diagnosis
P/E, PEG, P/S and EV/EBITDA measure the temperature of a valuation – quick, useful, comparable. But a thermometer doesn’t make a diagnosis: why a stock trades at 8 times or 40 times earnings can only be answered by looking at the business model, quality of growth and risks. Use the ratios as a filter and warning system – and distrust anyone who wants to sell you a stock based on a single number.
Frequently asked questions
What is a good EV/EBITDA value?
There is no universally good value. What matters is the comparison with direct competitors and the company’s own average over recent years. A low value can also be a warning sign of shrinking earnings.
EV/EBITDA or P/E – which is better?
EV/EBITDA is more meaningful when debt levels differ and depreciation is high; the P/E ratio is simpler and the better choice for banks and insurers. Ideally, read both side by side.
Why does EV/EBITDA differ depending on the data source?
Because net debt, leases and minority interests are included differently, and some sources adjust EBITDA. So only compare values from the same source.