Valuation Metrics: The Price Tags of the Stock Market

The Story of the Smart Shopper

Imagine you’re at a huge toy store. Every toy has a price tag. But here’s the secret smart shoppers know: the price alone doesn’t tell you if it’s a good deal.

A $50 toy might be a terrible deal if it breaks in a day. A $100 toy might be amazing if it lasts for years and brings endless joy.

Valuation metrics are your shopping tools for stocks. They help you figure out if a company’s stock price is a good deal, too expensive, or just right.

Let’s learn all 8 tools in your investor toolkit!

1. Earnings Per Share (EPS): The Pizza Slice Test

What is EPS?

Think of a company like a giant pizza. The profit is the pizza, and the shares are how many slices you cut it into.

EPS tells you: How much profit does each slice get?

EPS = Net Income ÷ Total Shares

Simple Example

Each share “owns” $10 of the company’s profit!

Why It Matters

• Higher EPS = More profit per share = Better!
• If EPS grows each year, the company is getting healthier
• If EPS shrinks, something might be wrong

Real World

• Apple’s EPS: ~$6 per share
• A tiny company might have EPS of $0.50
• Negative EPS means the company lost money

2. Price-to-Earnings Ratio (P/E): The Years-to-Pay-Back Calculator

What is P/E?

Here’s a fun question: If you bought a lemonade stand, how many years would it take to earn back your money?

The P/E ratio answers this exact question for stocks!

P/E Ratio = Stock Price ÷ EPS

Simple Example

Translation: If earnings stay the same, it takes 10 years of profits to equal what you paid.

The P/E Decoder Ring

graph TD
    A[P/E Ratio] --> B{What does it mean?}
    B --> C[Low P/E: 5-15]
    B --> D[Medium P/E: 15-25]
    B --> E[High P/E: 25+]
    C --> F[Might be cheap OR struggling]
    D --> G[Fairly priced]
    E --> H[Expensive OR fast-growing]

Important Truth

• Low P/E isn’t always good (company might be dying)
• High P/E isn’t always bad (company might be growing fast)
• Compare P/E to similar companies!

3. Price-to-Book Ratio (P/B): The Treasure Chest Value

What is P/B?

Imagine a treasure chest. Inside are gold coins, jewels, and valuable items. The book value is what’s actually IN the chest.

The stock price is what people are PAYING for the chest.

P/B Ratio = Stock Price ÷ Book Value Per Share

Simple Example

Translation: You’re paying $2 for every $1 of actual company stuff.

The Magic P/B Numbers

When P/B Shines

P/B works best for companies with lots of physical stuff:

• Banks (they have cash!)
• Real estate companies (they have buildings!)
• Manufacturing companies (they have factories!)

4. Dividend Yield: The Thank-You Gift Percentage

What is Dividend Yield?

Some companies share their profits with you like a thank-you gift. This gift is called a dividend.

Dividend Yield tells you: What percentage of your investment comes back as gifts each year?

Dividend Yield = (Annual Dividend ÷ Stock Price) × 100

Simple Example

Translation: For every $100 invested, you get $4 back each year!

The Yield Spectrum

graph TD
    A[Dividend Yield] --> B[0% - No dividend]
    A --> C[1-2% - Low but growing]
    A --> D[3-5% - Solid income]
    A --> E[6%+ - High but risky?]
    B --> F[Tech companies reinvest profits]
    C --> G[Companies balancing growth + income]
    D --> H[Stable mature companies]
    E --> I[Check if sustainable!]

5. Dividend Payout Ratio: The Sharing Score

What is Payout Ratio?

If you earn $10 allowance and give $3 to your piggy bank and $7 to spend, your “spending payout ratio” is 70%.

Payout Ratio tells you: What percentage of profits does the company give to shareholders?

Payout Ratio = (Dividends ÷ Net Income) × 100

Simple Example

What’s Healthy?

The Warning Sign

If payout ratio is over 100%, the company is paying MORE in dividends than it earns. That’s like spending more than your allowance. It can’t last!

6. Book Value Per Share: What’s Really Inside

What is Book Value Per Share?

Remember our treasure chest? Book Value Per Share tells you exactly how much treasure each share owns.

Book Value Per Share =
(Total Assets - Total Liabilities) ÷ Total Shares

Simple Example

Think of It Like This

graph TD
    A[Company Owns: $10M] --> B[Subtract What It Owes: $4M]
    B --> C[What's Left: $6M]
    C --> D[Divide by 100,000 shares]
    D --> E[Each share = $60 of real value]

Why It Matters

• If stock price is $50 but book value is $60, you might have a bargain!
• If stock price is $100 but book value is $60, you’re paying extra for future hopes

7. Market Capitalization: The Total Price Tag

What is Market Cap?

If someone wanted to buy the ENTIRE company, what would they pay? That’s Market Capitalization (Market Cap).

Market Cap = Stock Price × Total Shares

Simple Example

The Size Categories

Fun Fact

Apple’s market cap once hit $3 TRILLION. That’s $3,000,000,000,000!

That’s more than the entire economy of most countries!

8. Enterprise Value: The TRUE Price Tag

What is Enterprise Value?

Market Cap tells you the stock’s price. But what if the company has a huge credit card bill? Or a mountain of cash?

Enterprise Value gives you the REAL price to own the whole business.

Enterprise Value =
Market Cap + Total Debt - Cash

Simple Example

Why Add Debt and Subtract Cash?

graph TD
    A[Buy the Company] --> B[Pay the Stock Price: Market Cap]
    B --> C[But wait...]
    C --> D[You inherit their debts: +Debt]
    C --> E[You also get their cash: -Cash]
    D --> F[Enterprise Value = True Cost]
    E --> F

The Restaurant Example

Imagine buying a restaurant:

• Stock price: $500,000
• But it owes: $100,000 to suppliers
• It has: $20,000 in the cash register

True cost: $500,000 + $100,000 - $20,000 = $580,000

The Complete Toolkit: When to Use Each Metric

The Golden Rule

No single metric tells the whole story. Smart investors use multiple metrics together, like a doctor using multiple tests to understand your health.

A company with:

• High EPS (profitable!)
• Low P/E (cheap!)
• Healthy payout ratio (sustainable dividends!)
• Growing book value (building wealth!)

…is often a great find!

Your Turn

Next time you hear about a stock, ask:

1. What’s the P/E ratio? Is it reasonable?
2. Does it pay dividends? Is the yield good?
3. What’s the market cap? Is it stable or risky?
4. What’s the Enterprise Value? Any hidden debt?

You now have 8 powerful tools in your investor toolkit. Use them wisely!