Fundamental Analysis Basics (P/E, P/B, ROE, ROCE)

1. Price-to-Earnings Ratio (P/E Ratio)
What it Means

The P/E ratio tells you how much investors are willing to pay today for ₹1 of a company’s earnings. It connects a company’s market price with its profit generation ability.

Formula:
P/E = Current Market Price ÷ Earnings Per Share (EPS)

Why P/E Matters

A high P/E suggests that investors expect strong future growth.

A low P/E may indicate undervaluation, or that the company is facing growth challenges.

How to Interpret P/E

High P/E (>30): Market is optimistic, often seen in growth sectors like technology or consumer internet companies.

Moderate P/E (15–30): Indicates stable performance, common in quality midcaps and blue-chip stocks.

Low P/E (<15): Might indicate a value pick or a fundamentally weak company.

Limitations

P/E does not work well if profits are volatile or negative.

P/E differs widely across sectors—comparing a bank with a tech company is misleading.

Best Use Cases

Compare P/E with the stock’s historical average.

Compare P/E with the industry average.

Use Forward P/E (P/E using estimated future earnings) to understand growth visibility.

2. Price-to-Book Ratio (P/B Ratio)
What it Means

The P/B ratio compares the company’s market value with its book value (net assets). It tells how many times investors are paying relative to assets.

Formula:
P/B = Market Price per Share ÷ Book Value per Share

Book Value per Share = (Total Assets – Total Liabilities) ÷ Number of Shares

Why P/B Matters

Useful for asset-heavy sectors such as banks, NBFCs, manufacturing, and PSU companies.

Helps understand whether the stock trades above or below its actual net worth.

How to Interpret P/B

P/B < 1: Stock may be undervalued; the company trades below its net worth.

P/B between 1–3: Normal valuation for most companies.

P/B > 3: Indicates premium valuation; market expects strong future returns.

Limitations

Not useful for asset-light businesses like IT, FMCG, or digital companies where the real value lies in brand and intellectual property.

P/B alone does not measure profitability or efficiency.

Best Use Cases

Combine P/B with ROE to judge whether a company is generating strong returns on its net assets.

Valuable for evaluating banks and financial institutions.

3. Return on Equity (ROE)
What it Means

ROE shows how efficiently a company generates profits using shareholder equity. It reflects management’s ability to create value.

Formula:
ROE = Net Profit ÷ Shareholder’s Equity × 100

Why ROE Matters

High ROE indicates that the company uses shareholder money efficiently.

It reflects competitive advantage, pricing power, and strong demand.

How to Interpret ROE

ROE > 20%: Excellent – shows strong efficiency and high margins.

ROE 15–20%: Good – typical for stable companies.

ROE < 10%: Weak – indicates poor profitability or inefficient use of equity.

Limitations

ROE can be misleading if the company has very high debt; equity becomes smaller because debt funds the assets.

A temporary profit spike can artificially inflate ROE.

Best Use Cases

Compare ROE with the industry average.

Use ROE along with P/B to identify high-quality compounders.

Check 5–10 year ROE trends for consistency.

4. Return on Capital Employed (ROCE)
What it Means

ROCE measures profitability based on all capital employed, including equity and debt. It gives a more holistic view than ROE.

Formula:
ROCE = EBIT ÷ (Equity + Debt) × 100

Here, EBIT (Earnings Before Interest and Taxes) measures operating profit.

Why ROCE Matters

Shows how efficiently the company generates profits using both debt and equity.

Crucial for capital-heavy industries like manufacturing, steel, energy, or infrastructure.

How to Interpret ROCE

ROCE > 20%: Excellent capital allocation, highly efficient.

ROCE 15–20%: Good and sustainable.

ROCE < 12%: Weak returns relative to capital employed.

Limitations

ROCE may fluctuate due to capital expansion cycles.

Not very useful for debt-free companies where ROE already gives similar insight.

Best Use Cases

Compare ROCE with the company’s cost of capital (WACC).

High ROCE indicates strong pricing power and effective management.

How These Ratios Work Together

Using P/E, P/B, ROE, and ROCE in isolation is incomplete. Successful investors combine them for a full picture of valuation and performance.

1. P/E + ROE → Identifying Growth at Reasonable Price (GARP)

High ROE + reasonable P/E = High-quality stock at fair valuation.

Example: A company with ROE 20% and P/E 18 is usually attractive.

2. P/B + ROE → Banking and Financial Analysis

High ROE + moderate P/B = efficient bank with good asset quality.

A bank with ROE 17% and P/B 1.5 is stronger than a bank with ROE 10% and P/B 1.

3. ROCE + P/E → Capital-Intensive Business Screening

High ROCE suggests strong return on capital.

If P/E is low while ROCE is high, the stock may be undervalued.

4. ROE vs ROCE → Debt Analysis

ROE > ROCE: Company uses leverage (debt) to boost shareholder returns.

ROCE > ROE: Limited debt; equity is used more efficiently.

Practical Example (Simplified)

Suppose a company has the following metrics:

P/E = 20

P/B = 3

ROE = 22%

ROCE = 18%

Interpretation:

P/E 20 → Fair valuation.

P/B 3 → Market expects strong future performance.

ROE 22% → Very efficient with shareholder capital.

ROCE 18% → Strong use of total capital.

Conclusion:
This is a high-quality growth company trading at a fair-to-premium valuation.

How Investors Use These Ratios in Real World
1. For Long-Term Investors

Focus on businesses with consistently high ROE and ROCE.

Avoid companies with declining profitability, even if valuation looks low.

2. For Value Investors

Look for low P/E and low P/B stocks with improving ROE/ROCE.

These indicate potential turnarounds.

3. For Growth Investors

Accept high P/E if ROE and ROCE remain elevated for multiple years.

Growth sustainability is more important than cheap valuation.

4. For Traders

Use ratios to identify strong fundamentally-backed stocks for swing or positional trades.

Conclusion

P/E, P/B, ROE, and ROCE are essential tools of fundamental analysis. P/E and P/B help measure valuation, while ROE and ROCE measure profitability and efficiency. Together, they determine whether a stock is fundamentally sound, fairly priced, and capable of delivering long-term returns. When used consistently and compared with historical data, sector averages, and market conditions, these ratios give investors a powerful framework for making informed decisions.