If you are a value investor looking for undervalued companies, there are three key valuation metrics you can use as a starting point.
The first is what we call P/E ratio. Price-to-Earnings ratio is a great metric as it shows you how much investors are willing to pay for every Sh1 of a company’s earnings.
For example, Equity Group has a P/E ratio of 3.84x. This means investors are paying Sh3.8 for every Sh1 it earns annually. Honestly, this is low compared to many industry averages, and it can only mean two things: either it is undervalued or the market has low expectations for its future growth. You know which is true.
To compute P/E, you take:
Market price per share ÷ Earnings per share (EPS).
How to interpret the P/E ratio
a) Low P/E (e.g. 5–10)
The stock may be undervalued
b) Moderate P/E (e.g. 10–20)
The stock is likely fairly valued
c) High P/E (e.g. 25+)
The stock may be overvalued
Or investors expect high future growth
Nonetheless, don’t focus on P/E alone.
A low P/E + weak company -> you may fall into a value trap. A low P/E + strong growth -> that’s a great opportunity
The second is what we call P/B ratio. Price-to-Book ratio shows you how the market values a company compared to its net assets.
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A P/B of 1 means the company is valued exactly at its book value. A P/B below 1, for example Equity has a P/B of 0.8, which means the market is valuing the company below its net assets, which indicates a potential undervaluation.
A P/B above 1 means either it’s overvalued or the market expects future higher performance.
To compute P/B, you take: Share price ÷ Book value per share.
Book value per share is calculated as: (Total assets − total liabilities) ÷ number of outstanding shares.
The third is what we call P/S ratio. Price-to-Sales ratio shows you how much investors are willing to pay for every Sh1 of revenue a company generates.
It is calculated as: Market capitalization ÷ total revenue.
A lower P/S ratio may signal a possible undervaluation, while a higher P/S ratio may indicate a potential overvaluation or market expects strong growth. However, P/S comparisons should always be made within the same sector.
Key lesson in value investing
Many investors focus only on high share prices or hype, without checking whether the company is actually earning money or creating value underneath.
But a strong investing decision should always consider both price and fundamentals.
At the end of the day, value investing is not just about finding cheap stocks, but finding good businesses that are trading at reasonable prices, with strong fundamentals and sustainable earnings.
