PE versus PB ratio: Which one to use to assess a company’s health

Price-to-earnings (PE) ratio is a measure of the valuation of a company’s stock. It has price in the numerator and earnings in the denominator. The higher the PE ratio, the more expensive the stock or index is and vice-versa. You can figure out how expensive a stock is by comparing its PE with other similar companies or its own historical PE.

However, PE ratio by itself is not a conclusive indicator of a company’s financial health. For instance, you should also consider if the earnings are actually coming in as cash flows or exist on paper only.

The price-to-book (PB) ratio compares the price of the stock with its book (accounting value). The higher the PB ratio, more expensive is the stock and vice-versa. It gives you an idea of the assets backing the price of the stock in question.

This measure is more commonly used for banks but does not work very well with asset-light companies such as those in the information technology sector.

Whether PE is better or PB depends on the industry in question. Sometimes you need to take both into account to get an accurate picture of a company’s health and its financial prospects.