Reading the numbers
Valuation ratios — what you are paying
P/E, EV/EBIT, free-cash-flow yield and book-to-market answer one question in four ways - how much are you paying for each dollar of what the business produces?
The one question, asked four ways
A valuation ratio is a price tag divided by something the business actually produces. That is all it is. The disagreements between them are only about which price and which product.
- Price is either the equity (market cap, or one share) or the whole enterprise (equity plus debt minus cash — what an acquirer would really pay).
- Product is either accounting earnings, operating profit, cash, or the book value of what the company owns.
Pair them differently and you get P/E, EV/EBIT, free-cash-flow yield and book-to-market. Each pairing is honest about a different thing, and each is blind to something the others catch.
Why enterprise value exists
Two companies can trade at the same P/E while one is debt-free and the other is financed to the hilt. Buying the second one means inheriting its debt, and the P/E does not mention it.
Enterprise value adds debt and subtracts cash, so EV multiples compare the whole business rather than the sliver of it that equity holders own. This is why Greenblatt's screen ranks on EV/EBIT rather than P/E, and why our Value pillar leans on it.
The same ratio, on a real company
Here is one, computed by the same pipeline that prices it on every company page — not a number written into this lesson by hand.
Live from the Pythia pipeline
as of
- Formula
- Price / EPS (TTM)
- Source
- Graham (1949) The Intelligent Investor ch. 14
A ratio is a comparison, never a verdict
A P/E of 25 is not expensive. It is 25. Whether that is expensive depends on the growth ahead of it, the durability of the earnings underneath it, and what comparable businesses trade at.
This is precisely why Pythia z-scores every valuation input within its own GICS sector and country before scoring it. An 8x EV/EBIT is cheap for a software company and unremarkable for a European utility, and a score that ignored that would just be ranking sectors.
The four in detail
Price-to-Earnings (P/E)
InvestopediaShare price ÷ EPS (trailing twelve months)
How many dollars you pay for one dollar of annual earnings. A lower P/E usually means the market is paying less per dollar of profit — but only if earnings are stable and real.
Example
Stock trades at $150, EPS (TTM) = $6 → P/E = 150 ÷ 6 = 25×.
Peer median P/E in the same sector might be 18× — this stock looks richer unless growth is much faster.
How to read it: High P/E can mean high growth expectations, not necessarily a “bad” stock. Compare within the same sector.
EV / EBIT
InvestopediaEnterprise Value ÷ Operating Income
Values the whole business (debt + equity − cash) against operating profit. Lower multiples often mean “cheaper” operating earnings — used in Greenblatt-style screens.
Example
Market cap $10B, debt $2B, cash $1B → EV = $11B.
Operating income (EBIT) $1.1B → EV/EBIT ≈ 10×.
How to read it: Pythia’s Value pillar treats lower EV/EBIT as better after sector z-scoring.
FCF / EV (free cash flow yield)
InvestopediaFree Cash Flow ÷ Enterprise Value
Cash the business generates vs what you’d pay to own the whole company. Higher yield = more cash per dollar of enterprise value.
Example
FCF = $800M, EV = $10B → yield = 0.08 = 8%.
If peers average 4%, this company returns more cash relative to its price.
How to read it: Watch one-off capex or working-capital swings — a single great FCF year can mislead.
Book-to-Market (B/M)
InvestopediaBook equity ÷ Market cap
Classic “value” signal from Fama-French research: high B/M means the market prices the stock below accounting book value (value tilt).
Example
Book equity $4B, market cap $5B → B/M = 0.8.
B/M = 1.2 would mean book value exceeds market cap (deep value territory).
How to read it: Financials and tech often have book values that don’t reflect economic assets — always read sector context.
Sales yield (1 / P/S)
InvestopediaRevenue ÷ Market cap
Useful when earnings are negative or volatile — how much revenue you buy per dollar of market value. Pabrai-style discipline often caps price-to-sales.
Example
Revenue $2B, market cap $8B → sales yield = 0.25 (same idea as P/S = 4×).
How to read it: Low-margin businesses need higher sales yield (lower P/S) to be genuinely cheap.
Earnings yield spread (E/P − 10Y Treasury)
Investopedia(EPS ÷ Price) − 10-year Treasury yield
Compares the stock’s earnings “coupon” to a risk-free bond. Positive spread means equities offer more earnings yield than Treasuries — Buffett’s “equity bond” intuition.
Example
EPS/price = 5% (P/E = 20), 10Y Treasury = 4% → spread = +1%.
Spread turns negative when bonds look more attractive than the stock’s earnings yield.
How to read it: Macro rates move daily; Pythia uses the latest Treasury snapshot in the pipeline.
Do the division yourself
A multiple is one division. Put in a price and an earnings figure and watch what happens as earnings approach zero — the ratio does not get cheap, it stops meaning anything.
P/E calculator
Price / Earnings
25.0×
You are paying $150.00 for each $6.00 of annual earnings — about 25.0 years of them at today's rate.
Trailing EPS. A negative or near-zero EPS makes the ratio meaningless rather than cheap, which is why it refuses instead of printing a number.
Where each one lies to you
Every ratio has a denominator, and every denominator can be distorted:
| Ratio | What distorts it |
|---|---|
| P/E | One-off gains or write-downs; negative earnings make it meaningless, not cheap |
| EV/EBIT | Aggressive capitalisation of costs that peers expense |
| FCF yield | A single year of underinvestment, or a working-capital swing |
| Book-to-market | Intangible-heavy businesses whose real assets are not on the balance sheet |
The last one deserves emphasis. Book value counts factories well and brands, software and research badly, so a modern asset-light company can look permanently expensive on book-to-market while being nothing of the sort. The ratio is not broken; it is measuring something that has become less representative of what companies own.
Check yourself
3 questions. Nothing is recorded unless you are signed in, and nothing here affects anything else.
Sources
- Fama & French (1992), The Cross-Section of Expected Stock Returns (opens in a new tab) — Book-to-market as a priced characteristic, not merely a screen.
- Investopedia — Price-to-earnings ratio (opens in a new tab)
- Investopedia — Enterprise value (opens in a new tab) — Why EV multiples compare businesses that carry different debt loads.
Further reading
- Valuation: The Basics (opens in a new tab) — Damodaran — intrinsic vs relative valuation, multiples, and consistency (~28 min).
- Evaluating Stocks (opens in a new tab) — FINRA — P/E, P/S, debt-to-equity, and comparing to peers.
- Stocks & bonds (Khan Academy) (opens in a new tab) — Free course unit — market cap, dividends, and how stocks are priced.
- Valuation (opens in a new tab) — How investors estimate fair value for a stock.
- Enterprise value (opens in a new tab) — Why we value debt and cash together with equity.