Stock MarketIntermediate

Chapter 9 of 15

Key Financial Ratios Every Investor Must Know

P/E, P/B, ROE, D/E — ratios that reveal true value.

15 min read Chapter 9

Suresh was trying to decide between two banking stocks. HDFC Bank had a P/E of 18 while SBI had a P/E of 10. "SBI is cheaper — I should buy it!" he told his friend. His friend, a seasoned investor, stopped him. "P/E alone doesn't tell the whole story. Let's also check ROE, D/E, and P/B." Twenty minutes on Screener.in later, Suresh's picture of both companies had transformed completely. Financial ratios are the investor's quick scorecard for a company's health and valuation.

1. P/E Ratio — Price to Earnings

P/E Ratio (Price-to-Earnings):

The P/E ratio divides the current share price by the company's annual Earnings Per Share (EPS). It tells you how much investors are willing to pay for ₹1 of earnings. A higher P/E can indicate growth expectations or potential overvaluation.

Example: HDFC Bank P/E Calculation

HDFC Bank is trading at ₹1,600 per share. Its last 12 months' (TTM) EPS is ₹85. P/E = Share Price / EPS = ₹1,600 / ₹85 = 18.8×

This means investors are paying ₹18.80 for every ₹1 of HDFC Bank's annual earnings. HDFC Bank historically trades at 18–25× P/E, so 18.8× is at the lower end of its range — potentially attractive if earnings growth resumes.

2. P/B Ratio — Price to Book

P/B Ratio (Price-to-Book):

Price divided by Book Value Per Share (Shareholders' Equity / Shares Outstanding). A P/B below 1 means the market values the company at less than its net assets — often a value signal, but can also indicate the market expects asset write-downs or persistent low returns.

3. ROE — Return on Equity

ROE (Return on Equity):

Net Profit divided by Average Shareholders' Equity, expressed as a percentage. ROE measures how efficiently a company uses shareholders' money to generate profit. A higher ROE means better capital efficiency.

Example: ROE Calculation

A large NBFC reports:

Net Profit (PAT): ₹1,000 crore
Average Shareholders' Equity: ₹5,000 crore

ROE = ₹1,000 / ₹5,000 = 20%

This means for every ₹100 of shareholders' money invested, the company generates ₹20 of profit per year. An ROE above 15% sustained across 5+ years indicates an efficient, compounding business. Bajaj Finance and HDFC Bank are known for consistently delivering 15–20%+ ROE.

4. D/E Ratio — Debt to Equity

D/E Ratio (Debt-to-Equity):

Total Debt divided by Shareholders' Equity. Measures the extent to which a company is financing operations with debt vs equity. Higher D/E means more financial risk — especially when earnings are volatile.

5. PEG Ratio — P/E to Growth

PEG Ratio (Price/Earnings to Growth):

PEG = P/E Ratio divided by the company's expected earnings growth rate (%). A PEG of 1 is considered "fairly valued." PEG below 1 may signal undervaluation relative to growth; above 2 suggests the stock may be expensive relative to growth prospects.

6. Dividend Yield

Dividend Yield = Annual Dividend Per Share / Current Share Price × 100

Coal India, for example, consistently pays a high dividend. At a ₹225 share price and ₹25 annual dividend: Dividend Yield = 11.1%. High dividend yield can indicate undervaluation — or that the market expects earnings to fall (value trap risk). Always verify the sustainability of dividends.

P/E Comparison Across Sectors

Sector	Typical P/E Range	Why This Range	Nifty 50 Examples
IT Services	25–35×	Stable growth, high margins, strong cash flows command premium	TCS (28×), Infosys (25×)
FMCG	40–65×	Defensive, brand moat, consistent earnings command very high premium	HUL (58×), Nestle India (75×)
Private Banks	15–25×	Moderate growth, capital-intensive, regulatory constraints	HDFC Bank (18×), ICICI Bank (17×)
PSU Banks	6–12×	Lower ROE, NPAs, government interference risk → discount	SBI (10×), Bank of Baroda (7×)
Auto	20–30×	Cyclical but large market opportunity; EV transition premium	Maruti (25×), Bajaj Auto (27×)
Pharma	25–40×	R&D pipeline optionality, export markets, patent cliff risk	Sun Pharma (35×), Cipla (28×)

High P/E ≠ Expensive, Low P/E ≠ Cheap — Use PEG

A stock with a P/E of 50 growing earnings at 35% per year has a PEG of 1.4 — reasonable. A stock with P/E of 12 growing earnings at 3% has a PEG of 4 — expensive! Always compare P/E to the company's own historical average and its growth rate. Buying a PSU bank at P/E 10 sounds cheap — but if ROE is 6% and growth is minimal, it may be expensive relative to a private bank at P/E 20 growing earnings 25% annually.

ROE above 15% consistently is a quality signal

Businesses that sustain ROE above 15% for 5+ years (without using excessive leverage) are generating compounding returns on capital. Companies like HDFC Bank, Bajaj Finance, and Asian Paints have maintained 15–25%+ ROE for over a decade — their shareholders have been handsomely rewarded. Screener.in shows 10-year ROE trends.

Quick Quiz

What does the P/E ratio measure?

Key Takeaways

P/E measures how much you pay for earnings; P/B measures price vs book value; ROE measures how efficiently equity generates profit — use all three together, not in isolation.
P/E varies dramatically by sector — FMCG trades at 40–65× while PSU banks trade at 6–12×; always compare within the same sector and against the company's own history.
PEG ratio adjusts P/E for growth — a PEG below 1 is generally undervalued; PEG above 2 may indicate the stock is pricing in too much growth.
ROE above 15% sustained over 5+ years (without excessive debt) is one of the best indicators of a quality compounding business.

Ch 8: How to Read a P&L Statement

Ch 10: Technical Analysis — Introduction