Bret Kenwell
By Bret Kenwell

Boot Camp Day 3: Key Ratios to Know

The Daily Breakdown dives into Day 3 of the fundamental analysis boot camp, discussing the key ratios that investors have to know.

For those interested in other parts of the Fundamental Analysis Boot Camp, consider the following links: 

Quick TLDR

  • Financial ratios help measure stock values
  • There are a few key ones to know

What’s Happening?

Yesterday we talked about key financial metrics. Today we’ll talk about how to measure them. 

However, there’s one caveat to know: Not all industries are created equal. 

Just because some stocks appear to have a low valuation, doesn’t mean they’re cheap. Conversely, just because others have a seemingly high valuation, doesn’t necessarily make them expensive. 

It’s often more important to compare specific stocks to the valuation of their peers or to their historical valuations. That lets us know if the stock is relatively cheap or expensive compared to its past valuation or to its industry peers. When you compare different stocks from different sectors, it has the potential to produce misleading conclusions; it can be apples to oranges, and we usually want to keep it apples to apples.  

Key Ratios and Metrics (formulas below)

One of the most widely used metrics is the Price-to-Earnings (P/E) ratio, which divides a company’s current share price (P) by its earnings (E). A lower P/E might indicate a stock is undervalued, while a higher P/E could suggest it’s overvalued.

However, the P/E ratio doesn’t consider a company’s growth rate. That’s where the PEG ratio (Price/Earnings Growth) comes in. 

It divides the P/E ratio by the company’s expected earnings growth rate. A PEG ratio around 1 is often seen as fairly valued, while a reading below 1 may suggest undervaluation relative to growth. This makes it useful for comparing growth-oriented companies. Over 1 is okay too, but investors should do some extra digging to determine if the stock might be overvalued. 

The Price-to-Book (P/B) ratio compares a company’s stock price to its book value (assets minus liabilities). A P/B ratio under 1 might indicate a stock that’s trading for less than the value of its net assets, which can be attractive for value investors — though it’s more relevant in asset-heavy industries like banking or manufacturing.

Liquidity and short-term financial health are also important. 

The Quick Ratio measures a company’s ability to meet short-term liabilities using its most liquid assets (excluding inventory). A ratio above 1 suggests the company can cover its short-term obligations without relying on inventory sales.

Each of these metrics provides a different lens. Used together, they give a fuller picture of a company’s valuation and financial stability. Still, no single metric should drive an investment decision. Ultimately, successful fundamental investors combine these tools with broader financial analysis to identify well-priced, high-quality companies for long-term investment.

Formulas

P/E (Price-to-Earnings) Ratio
Measures how much investors are willing to pay per dollar of earnings.
Formula: Stock Price ÷ Earnings Per Share (EPS)
Use: Evaluates whether a stock is over- or undervalued based on profits.

 

PEG (Price/Earnings Growth) Ratio
Adjusts the P/E ratio by factoring in expected earnings growth.
Formula: P/E Ratio ÷ Annual EPS Growth Rate
Use: Helps assess valuation relative to growth.

 

P/B (Price-to-Book) Ratio
Compares a stock’s market value to its book value (assets minus liabilities).
Formula: Stock Price ÷ Book Value Per Share
Use: Indicates how much investors pay for each dollar of net assets.

Quick Ratio

Formula: (Current Assets − Inventory) ÷ Current Liabilities

Use: Measures a company’s ability to meet short-term obligations using its most liquid assets; excludes inventory to provide a stricter test of liquidity.

Disclaimer:

Please note that due to market volatility, some of the prices may have already been reached and scenarios played out.