Lesson 3 of 4 · 10 min read
Valuation: is the stock expensive?
A great company can be a bad investment if you overpay. Valuation tells you the price.
Price says nothing without context
A €10 share is not 'cheaper' than a €500 one. It's about what you get for that price: how much profit, growth and assets are behind it? For that you use valuation ratios that relate the price to the fundamentals.
The price-earnings ratio (P/E)
The best-known ratio: price divided by earnings per share. A P/E of 20 means you pay €20 for every €1 of annual profit. Roughly: the higher the P/E, the more growth the market expects — and the more you pay up front for that expectation.
In practice
A share costs €50, earnings per share is €2.50. P/E = 50 / 2.50 = 20. You pay 20 annual profits for this share.
High or low — what is 'good'?
There is no magic number. A growth company deserves a higher P/E than a stable, slow company, because its profit will be much larger later. So compare the P/E with (1) sector peers and (2) the company's own history. A P/E far above both can mean 'expensive'.
Stocky says
A low P/E is not automatically a bargain: sometimes it's low because the market rightly expects decline or problems. That's called a 'value trap'.
Adding growth: the PEG ratio
The PEG divides the P/E by the expected profit growth (%). A P/E of 30 sounds expensive, but with 30% growth the PEG = 1.0 — often seen as 'reasonable'. This way you correct the P/E for how fast a company grows.
Valuation is a compass, not a GPS
Ratios give direction, not certainty. They are based on expectations that can change. Use them to understand which expectations are priced into the share — and ask yourself whether those are realistic. That, plus a moat, plus healthy figures, together forms your judgment.
'Price is what you pay, value is what you get'
Even the best company in the world is a bad investment at an absurdly high price. Valuation determines whether your future return goes for or against you.
Remember this
- An absolute price says nothing; valuation ratios relate the price to the fundamentals.
- The P/E shows how many annual profits you pay for a share — compare with the sector and its own history.
- A low P/E is not automatically a bargain: it can be a value trap.
- The PEG corrects the P/E for expected profit growth; ratios are a compass, not a certainty.
There is a quiz for this lesson
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