Is a P/E of 20 expensive?
Every stock quote page lists a P/E ratio, and many list P/B as well. One company shows 6, another shows 40, and the lower number looks like the bargain. But neither figure is a price tag. Each one describes how the market is currently valuing a company's earnings or its accounting equity, and that valuation already reflects expectations about growth, risk, and how durable the profit is.
This guide walks through how both ratios are calculated, why they are tied together by return on equity, how one-time gains can make a stock look cheaper than it is, and which parts of an annual report let you check the inputs yourself. The aim is not to label a stock cheap or expensive. It is to work out why the multiple is where it is.
P/E: price divided by earnings per share
FINRA's investor guide describes the P/E ratio as the current share price divided by earnings per share (EPS), and calls it a commonly quoted measure of stock value. A stock trading at $80 with EPS of $4 has a P/E of 20. Put simply, if earnings stayed flat, buyers are paying twenty years of current profit for each share.
The denominator matters. A trailing P/E uses the last four reported quarters; a forward P/E uses analyst estimates for the coming year, which can be revised or simply wrong. For a group that consolidates subsidiaries, the relevant figure is net income attributable to the parent company's shareholders, not total net income. Before comparing two companies, make sure the ratios you are looking at use the same kind of earnings.
P/B: price divided by book value per share
P/B divides the share price by book value per share, where book value is shareholders' equity: total assets minus total liabilities on the balance sheet. The SEC's Beginners' Guide to Financial Statements explains the balance sheet in exactly those terms. A P/B of 1 means the market values the company at roughly its accounting equity.
Book value says nothing about the quality of the assets behind it. A hundred million dollars of cash, a factory, slow-moving inventory, and goodwill from an old acquisition can all sit on the same line of equity, yet they differ enormously in what they would fetch or earn. P/B is most informative for banks and insurers, whose assets are largely financial. For software or brand-driven businesses, much of the value comes from intangibles that never appear on the balance sheet, so a high P/B is normal rather than alarming.
Reading P/E, P/B, and ROE together
The two ratios are linked. Divide P/B by P/E and the share price cancels out, leaving earnings divided by equity, which is return on equity (ROE). In other words, P/B = P/E × ROE, always. That identity lets you ask whether a high P/B comes from paying a lot for each dollar of profit or from a business that earns a high return on its capital.
The table below uses three hypothetical companies. They are not real stocks; the numbers are chosen only to show the arithmetic.
| Company | Price | EPS | Book value / share | P/E | P/B | ROE |
|---|---|---|---|---|---|---|
| A | $80 | $4.00 | $40 | 20× | 2.0× | 10.0% |
| B | $30 | $5.00 | $60 | 6× | 0.5× | 8.3% |
| C | $120 | $3.00 | $20 | 40× | 6.0× | 15.0% |
ROE = EPS ÷ book value per share. For every row, P/B = P/E × ROE (Company A: 20 × 10% = 2.0).
Questions the table raises
Company B looks cheapest on both measures, at 6 times earnings and half of book value. It also has the lowest ROE. The market may expect its capital to keep earning weak returns, or it may doubt that some of the assets are worth their carrying value. A low multiple only becomes an opportunity after you have a good answer to that doubt.
Company C looks the most expensive at 40 times earnings, but it earns 15% on its equity. Its multiple contains both high capital efficiency and an expectation of growth. The same numbers also show the risk: if that expectation fades and the P/E falls from 40 to 25 with earnings unchanged, the share price drops by 37.5%.
When a one-off gain makes P/E look low
Net income can include items that will not repeat, such as a gain from selling a building or a stake in another company, a fair-value gain on investments, or an unusual tax benefit. In the year such a gain lands, EPS rises and the P/E looks lower than the underlying business justifies. A large impairment does the opposite and can make the ratio meaningless for that year.
Suppose $1.50 of Company A's $4.00 EPS came from an after-tax gain on a property sale.
| Basis | EPS | P/E at $80 |
|---|---|---|
| Reported net income | $4.00 | 20× |
| Excluding the property gain | $2.50 | 32× |
Stripping out the non-recurring gain moves the P/E from 20 to 32 at the same share price.
Three common misreadings
First, a P/B below 1 does not mean shareholders would profit if the company were wound up. Book value is not a sale price. Inventory and equipment often sell for less than their carrying amount, and liquidation costs and creditors come first.
Second, a company's adjusted or non-GAAP earnings are not automatically a better denominator. Adjusted figures depend on what management chooses to exclude. If restructuring charges show up every year and are labeled non-recurring every year, they are part of the cost of running the business.
Third, P/E ratios do not compare cleanly across industries. In cyclical sectors such as semiconductors, shipping, or commodities, profits peak at the top of the cycle, so the P/E tends to look lowest exactly when earnings are least sustainable. For these businesses it helps to look at average earnings across several years.
Checking the inputs in a 10-K
The ratio shown in a brokerage app rarely tells you which earnings or share count it used. For U.S.-listed companies, the annual 10-K and quarterly 10-Q on the SEC's EDGAR system contain the raw inputs. A practical order:
- In Item 8 (financial statements), find net income attributable to the company and basic and diluted EPS on the income statement.
- Read the notes on other income and gains to see whether asset sales, investment gains, or tax items inflated the year's profit.
- On the balance sheet, find total stockholders' equity attributable to the company and check how much of it is goodwill and other intangibles.
- Check shares outstanding on the cover page, and treasury stock on the balance sheet, before calculating book value per share.
- If the earnings release highlights adjusted EPS, use its reconciliation table to see exactly what was excluded and whether the same items recur.
What a multiple cannot tell you
P/E and P/B divide today's price by past or current figures. They do not forecast future profits or prices. When interest rates rise, the market may pay a lower multiple for the same earnings, and when an industry changes, its historical range of multiples stops being a useful anchor.
All figures in this guide are hypothetical; any real comparison should use each company's latest filings and note the date of the data. P/E and P/B are most useful as prompts: will these earnings last, do these assets produce cash, and is the share count growing?