At some point in every stock market conversation, someone will say "that stock looks expensive" or "this one is cheap." But cheap compared to what? A share of Nvidia costs hundreds of pounds. A share of a penny stock costs a few pence. Price alone tells you almost nothing. Valuation is about figuring out whether a company's market price reflects what it's actually worth.
The Price-to-Earnings ratio compares a company's share price to how much it earns per share per year. If a company earns £2 per share and trades at £30, its P/E is 15. That means you're paying £15 for every £1 of annual earnings.
Is 15 cheap or expensive? Historically, the S&P 500 has averaged a P/E around 15–20. Right now it's higher. Growth companies like Tesla or Amazon have often traded at P/Es above 100 — meaning investors are paying for future earnings growth, not current earnings. Value companies often trade at P/Es under 10, suggesting the market thinks growth will be slow.
A high P/E means one of two things: the market thinks earnings will grow rapidly (so the price is justified), or the stock is genuinely overpriced (so the price will fall). The challenge is knowing which. Nobody gets this right consistently.
EPS is the company's total profit divided by the number of shares outstanding. If Apple makes $100 billion in profit and has 16 billion shares outstanding, EPS is about $6.25. Multiply that by the P/E and you get the share price. Simple in theory; complex in practice because companies can manipulate EPS by buying back shares, which reduces the share count and makes EPS look better even if profits are flat.
Market cap = share price × number of shares. Apple at $220 per share with 15.5 billion shares outstanding has a market cap of around $3.4 trillion. That's the market's current assessment of the entire company's value. It's useful for comparisons — a £50 stock with 1 million shares (£50m market cap) is a tiny company; a £10 stock with 10 billion shares (£100bn market cap) is a giant.
| Category | Market cap | Typical characteristics |
|---|---|---|
| Mega-cap | $200bn+ | Apple, Microsoft, Nvidia — most stable, lowest growth |
| Large-cap | $10–200bn | Established companies, lower risk, moderate growth |
| Mid-cap | $2–10bn | Growing companies, more volatile, more upside potential |
| Small-cap | $300m–2bn | Higher risk, higher potential returns, less analyst coverage |
| Micro/Penny | Under $300m | Very high risk, often loss-making, easy to manipulate |
Book value is what's left if you sold all of a company's assets and paid off all its debts. It's the accountant's version of what the company is "really" worth, without any premium for future growth. The Price-to-Book (P/B) ratio compares the share price to book value per share. A P/B below 1 means the stock trades below what its assets are worth on paper — theoretically a bargain, but often a sign the market doesn't believe the assets are worth what the books say.
Valuation is not an exact science. These ratios are tools for comparison, not verdicts. A company with a P/E of 50 can be a better investment than one with a P/E of 8, if the first one grows earnings at 40% per year and the second grows at 2%. The ratios are snapshots. The story matters too — but you need the numbers to anchor the story.
What professional investors actually do: they use ratios to screen out obviously overpriced or underpriced stocks, then dig deeper into the ones that look interesting. Nobody buys or sells based on a P/E alone. The ratio is the start of the question, not the answer.
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