Step 07

P/E, P/B, EV/EBITDA, and When to Use Them

Level: beginner

Learning objectives

Understand the nature of p/e, p/b, ev/ebitda and the use cases in asset valuation.
Know how to relate this topic to cash flow, risk, and buy and sell decisions.
Identify important assumptions that could change the valuation results.
Apply a simple valuation checklist to a specific asset.

Why it matters

Valuation is the bridge between analysis and action

P/E, P/B and EV/EBITDA are popular valuation ratios, but each is only appropriate in certain contexts. Without valuation, investors can easily buy good assets at too high valuations or miss opportunities because they only look at short-term fluctuations.

Value depends on assumptions

P/E is more suitable for businesses with stable earnings. P/B is useful for the financial industry or assets with significant book value. EV/EBITDA helps compare businesses with different capital structures, but ignores capex, taxes and working capital. No multiple can replace business quality analysis. Because all valuations contain uncertainty, investors need to understand what is driving value up or down.

It helps manage capital better

Valuation not only answers whether to buy, but also helps decide how much to buy, what margin of safety to require and when to review.

Core lesson

The essence of the lesson

P/E, P/B and EV/EBITDA are popular valuation ratios, but each is only appropriate in certain contexts.

Valuation is not about finding a perfect number. Valuation is the process of turning knowledge about the business, cash flows, risks and time horizon into a reasonable range of value. That value range helps investors compare with market prices and make more disciplined decisions.

Analytical framework

A good valuation model must be consistent with the quality of the business. A high-growth business that requires too much capital may not be worth as much as it seems. Businesses with high margins but weak moat also need to be discounted. Conversely, stable businesses with good cash flows and reliable management may deserve higher-than-average valuations.

How to apply

Before using a ratio, ask whether the denominator accurately reflects the sustainable earning power of the business.

When valuing, start with simple assumptions and test sensitivity before building complex models. Ask whether the results depend most on growth, margins, cost of capital or terminal value. If even a small change causes the conclusion to reverse, decide that a larger margin of safety is needed.

Mistakes to avoid

Using a single ratio for every industry and every cycle stage.

Valuation can create a sense of control because the spreadsheet has a lot of numbers. But the future is not as precise as a spreadsheet. Always present valuations as ranges, clearly state key assumptions, and connect results to position size rather than looking at valuation as the only answer.

Key terms

P/E

Stock price divided by earnings per share.

P/B

Market value divided by book value of equity.

EV/EBITDA

Enterprise value divided by earnings before interest, taxes, depreciation, and amortization.

Classification

According to the valuation method

Valuation can be based on relative multiples, discounted cash flows, net assets, normalized earnings, or implied expectations. Each method has its own strengths and limitations.

According to the reliability of the assumption

Assets with stable cash flows are often easier to value than assets with high growth, strong cyclicality or reliance on new technology.

Follow investment action

Valuation results need to be translated into decisions to buy, hold, sell, monitor, or cap position size based on the margin of safety and risk.

Real-world examples

Illustrative situation

Application in asset valuation

Low EV/EBITDA may be attractive to businesses with little capex, but misleading to businesses that have to invest in large machinery each year to maintain operations.

When valuation is superficial

Risk analysis

Using a single ratio for every industry and every cycle stage. This could lead investors to be overconfident in a very fragile valuation conclusion.

Common mistakes

Viewing valuation as an exact number

The value should be understood as a probability range because all assumptions about the future are subject to error.

No sensitivity test

Without knowing which assumptions have the strongest impact, it is difficult for investors to know how reliable the model is.

Separating valuation from business quality

Using a single ratio for every industry and every cycle stage. A low price is not attractive enough if the business is weakening or cash flow is difficult to forecast.

Practical application

Pricing checklist

Identify assets that need to be valued and main sources of cash flow generation.
Before using a ratio, ask whether the denominator accurately reflects the sustainable earning power of the business.
Choose the appropriate method: relative multiple, DCF, net assets or a combination of methods.
Create a conservative, baseline, and optimistic scenario instead of just one number.
Turn results into action: buy, hold, monitor, sell or limit weight.

Exercises

Exercise 1 - reflection

Choose an asset you are interested in and analyze it from the perspective of p/e, p/b, ev/ebitda and usage conditions.

Exercise 2 - case_study

Low EV/EBITDA may be attractive to businesses with little capex, but misleading to businesses that have to invest in large machinery each year to maintain operations. Identify the most important valuation assumptions and risks of bias.

Exercise 3 - action_plan

Create a 5-step checklist to convert a valuation result into a capital allocation decision.

Key takeaways

P/E, P/B and EV/EBITDA are popular valuation ratios, but each is only appropriate in certain contexts.
P/E is more suitable for businesses with stable earnings. P/B is useful for the financial industry or assets with significant book value. EV/EBITDA helps compare businesses with different capital structures, but ignores capex, taxes and working capital. No multiple can replace business quality analysis.
Principle of practice: Before using a multiple, ask whether the denominator accurately reflects the sustainable earning power of the business.
Mistake to avoid: Using a single ratio for every industry and every cycle stage.
Good valuation is about understanding the valuation range, key assumptions, margin of safety, and how to translate the results into capital decisions.