PosiStep 14: Key ratios and their limits: P/E, P/B, ROE, ROCE, debt
Ratios turn the numbers from the last three PosiSteps into quick comparisons. No single ratio tells the whole story, but together they show how a company earns, how it is financed and how the market prices it.
P/E: price compared with profit
P/E (price to earnings) = share price ÷ EPS. A P/E of 20 means investors pay ₹20 for every ₹1 of yearly profit per share. A higher P/E usually means the market expects more growth; a lower P/E can mean low expectations, or problems.
P/E has no meaning for a loss-making company, and one unusual year can distort it. Compare P/Es within the same industry.
P/B: price compared with book value
P/B (price to book) = share price ÷ book value per share. Below 1 means the share trades for less than the company's book value; well above 1 means investors value it far above its accounting net worth.
P/B is most useful for asset-heavy businesses such as banks. For software or brand-led companies, much of the value never appears on the balance sheet, so their P/B is naturally high. If equity is tiny or negative, P/B becomes meaningless.
ROE and ROCE: how well money is used
ROE (return on equity) = net profit ÷ equity. It shows how much profit the company makes on shareholders' money: ₹20 profit on ₹100 of equity is a 20% ROE.
ROCE (return on capital employed) = operating profit ÷ (equity + borrowings). It also counts borrowed money, so a company cannot look good just by borrowing more. High ROE with high debt deserves a closer look.
Debt and safety ratios
Debt-to-equity (PosiStep 12) shows borrowing compared with own capital. Current ratio = current assets ÷ current liabilities; above 1 means short-term assets cover short-term bills.
Interest coverage = operating profit ÷ interest. A coverage of 5 means profit covers interest five times; close to 1 or below means interest is eating most of the profit. PositoAI's Owes vs Owns adds a simple whole-balance-sheet view.
Using ratios sensibly
Compare a ratio with the company's own past and with similar companies, not with a fixed "good number". Look at several ratios together: a low P/E with falling profits and high debt tells a very different story from a low P/E with rising profits and no debt.
Where PositoAI fits
The Funda tab (PosiFunda) explains P/E, P/B, ROE, Owes vs Owns, dividend yield, growth and margins for each company in plain words, compared with similar companies. The low PE, below book value, high ROE and high ROE + low PE Top 10 lists group companies by these ratios.
Key terms
- P/E
- Share price ÷ EPS: rupees paid per ₹1 of yearly profit per share.
- P/B
- Share price ÷ book value per share.
- ROE
- Net profit ÷ equity: profit made on shareholders' money.
- ROCE
- Operating profit ÷ (equity + borrowings).
- Current ratio
- Current assets ÷ current liabilities.
- Interest coverage
- Operating profit ÷ interest.
Try it
Made-up company Lark Software trades at ₹300 per share and has an EPS of ₹15. Its book value per share is ₹60. What are its P/E and P/B?
P/E = ₹300 ÷ ₹15 = 20. P/B = ₹300 ÷ ₹60 = 5. Investors pay ₹20 per ₹1 of yearly profit and 5 times the book value.
See it live on PositoAI
Open Infosys's Funda tab and read how its P/E and ROE compare with similar companies. Then open the high ROE + low PE Top 10 list for India.
What this does not tell you
Every ratio has blind spots: P/E fails for loss-makers, P/B misleads for asset-light companies, ROE can be pumped up by debt. Ratios describe the past and present, not the future, and never tell you on their own whether to buy.
Quick quiz
Share price ₹500, EPS ₹25. What is the P/E?
P/E = ₹500 ÷ ₹25 = 20.
A P/B below 1 means:
P/B below 1 means the share price is less than the book value per share.
Net profit ₹40 Cr, equity ₹200 Cr. What is the ROE?
ROE = ₹40 Cr ÷ ₹200 Cr = 0.20, which is 20%.
Why is ROCE useful alongside ROE?
ROCE uses equity plus borrowings, so a company cannot look efficient just by taking on more debt.
Interest coverage of 1.2 suggests:
Operating profit only 1.2 times the interest means interest takes most of the profit, leaving little margin of safety.
Answer every question on this page correctly to complete this PosiStep.
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PosiCourse is for education only. It does not recommend buying or selling any share. Examples with made-up numbers are not real companies. PositoAI is for research and education only and is not investment advice.