Choosing a valuation metric: different companies need different yardsticks

There is more than one valuation metric for gauging whether a share price is high or low. PER, PBR, PSR and EV/EBITDA all ask about price level, but each puts a different number in the denominator. PER uses earnings, PBR net assets, PSR sales, and EV/EBITDA the cash-generating power of the core business.

So rather than one metric being right, what matters is choosing the yardstick that fits the kind of company. A yardstick that suits a company with steady earnings may not even be calculable for one still posting losses. This article sets out in one place which yardstick makes sense for which company.

PER (price to earnings ratio) is the most widely used basic yardstick. It divides the share price by earnings per share to show how many times its earnings the company is priced at. For a company that earns steadily every year, PER alone gives a fair sense of the price level.

But PER cannot be calculated for loss-making companies with negative earnings, and for companies with erratic earnings its value jumps around and loses meaning. It helps to remember it as the most reliable yardstick when earnings are stable.

PBR makes sense for companies whose assets are the basis of the business, such as banks, insurers and brokerages, or manufacturers heavy in plant and property. It divides the share price by net assets per share to show how many times the net assets on the books the market is paying.

A PBR below 1 means the market values the company at less than its book value. But at companies whose core assets, such as brands or technology, barely show up on the books, PBR cannot capture the real value, so it fits them poorly.

Growth companies still establishing themselves, with thin profits or losses, cannot be measured with PER. This is where PSR comes in. It divides market cap by sales to show how many times each unit of sales the market is paying. Even without profit there are sales, so a value comes out.

But PSR looks only at sales, not at how much of those sales is left as profit. So it gains meaning only alongside net margin and operating margin, comparing companies in the same margin range.

For companies with heavy debt and heavy depreciation on plant, such as telecoms, steel and energy, PER, which looks only at market cap and net income, is easily distorted by capital structure. Here EV/EBITDA becomes the yardstick. It divides enterprise value, market cap plus net debt, by operating profit before interest, taxes, depreciation and amortization.

Because it compares the value of the whole company, debt included, with the cash-generating power of the core business, companies with different capital structures can be set against the same yardstick. But EBITDA adds back depreciation and so hides investment the business actually needs, which can make cash flow look better than it is.

In short, the yardstick depends on the company: PER for steady earnings, PBR for asset-based businesses, PSR for growth companies still posting losses, and EV/EBITDA for heavy debt or depreciation. But this is only an order of priority, not a rule to look at a single metric.

The safest approach is to layer two or three yardsticks and check whether they point the same way or diverge. If the metrics disagree, that in itself is a sign to look closer.

No valuation metric is the final answer on high or low; each is a starting point for asking why the price is what it is. Jupick shows these metrics as numbers on the stock page and gives no trading advice on any stock. This content is for information only and is not investment advice.