High Price-Earnings & a Low Market-to-Book Ratio

by Chirantan Basu
A high price-to-earnings ratio may indicate good earnings performance, or it may mean the stock is overpriced.


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Financial ratios allow investors and other stakeholders to evaluate a company's historical performance and compare it to other companies, industries and stock markets. Valuation ratios, such as price-to-earnings and price-to-book, may indicate overvaluation or undervaluation with respect to industry or market averages. Investors generally profit from buying undervalued stocks and selling overvalued stocks.


The price-to-earnings ratio is the ratio of the current share price to the trailing 12-month earnings per share. Some may calculate the price-earnings ratio based on future earnings estimates. The market-to-book ratio, also known as the price-to-book ratio, is the ratio of the current share price to the book value per share. Book value equals shareholders' equity, which equals assets minus liabilities. High valuation ratios relative to the market or industry averages generally indicate a high level of investor interest, while low valuation ratios normally indicate a low level of interest.

High Price-Earnings Ratio

A high price-earnings ratio could indicate overvaluation, meaning the share price is expensive relative to other companies or the overall market. Stocks in high-growth industry sectors, such as Internet technology, may have high price-earnings ratios because investors expect these companies to demonstrate high year-over-year profit growth. A low price-earnings ratio may indicate general market pessimism about a company or industry's growth prospects. Stocks with high price-earnings ratios may be more volatile, because even the smallest bit of bad news could knock the price down significantly.

Low Market-to-Book Ratio

A low market-to-book ratio could indicate undervaluation or it could be the result of negative market sentiment about the company's prospects. During a recession, markets may knock down the stock prices for companies in cyclical industries, such as transportation and retail. However, a low market-to-book could also result from excessive market pessimism based on recent company restructuring actions and other negative industry news.

Investment Strategies

Ideally, an investor wants to buy a stock at its low point and sell it at its peak. However, market timing is difficult because a high-price-earnings-ratio stock could climb higher, while a low-market-to-book stock could decline further. Some investors may set price targets for trading stocks, such as buying or selling when a stock is a certain level above or below the price-earnings or other valuation ratios. A long-term investor may buy a stock only if it is trading below its book value, which means a market-to-book ratio less than 1, and may sell when the price-earnings ratio is higher than the industry average. Investors may use the Resource links and other free online sources to review industry financial ratios.


If a stock is trading at $20 today and its trailing 12-month earnings are $1.10 a share, the trailing price-earnings ratio is about 18 ($20/$1.10). If the total assets and liabilities are $2 million and $1 million, respectively, and the company has 1 million shares outstanding, then its book value is $1 per share [($2 million - $1 million)/1 million = $1] and the market-to-book ratio is 20 ($20/$1).

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