As Warren Buffett says, price is what you pay, and value is what you get. If the markets were perfect, price and value would go hand in hand, but as we all know, markets aren't perfect.
Once you appraise the business value, look at price and use valuation ratios to connect the price to the business.
PE: This is where most investors start, but it doesn't tell the whole story.
EY: Value investors look at present and future earnings yield (1/PE).
PEG: Price earnings to growth relates PE to growth rates and tells you something about that earnings yield future.
P/S, Profit Margin, P/B, and ROE: The relationships between price and these are also important.
For example:
FD interest rate = 3%.
PE of FD = 33.3.
So a PE of 25 or less is good given today's alternative earnings yields, but it doesn't mean that much without looking at the other numbers.
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These valuation ratios are good signs (of value) for growing companies:- a PEG of 2 or less,
- a P/S of 3 or less, and
- a P/B of 5 or less.
Lower figures of these valuation ratios can be expected for steady or transitioning companies.
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Good Business, but Stock is too Expensive
Generalising is hard, but PE, PEG, P/S, and P/B well in excess of market or industry averages spell trouble in making the numbers, as does overdependence on abnormal margins.
These valuation ratios are signs of overcooked prices and raise questions of vulnerability and (un-)value:
PE: Look at PE compared to the market and the industry. A PE over 40 is hard to justify in any case. PE over 25 is hard to justify unless the growth story is there and intact.
EY: EY below 2.5%
PEG: PEG greater than 3
P/S: P/S greater than 3
P/B: greater than 10
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