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World 7 · Fundamentals and news · lesson 5 · level 3

More valuation tools: P/B, P/S and dividend yield

Different ratios compare the price with different things: what a company owns, what it sells and what it pays out.

In one line

Different ratios compare the price with different things: what a company owns, what it sells and what it pays out.

Explained simply

Imagine judging a bakery three ways: by the value of its ovens and shop, by how much bread it sells, and by how much cash it hands its owners each year. Each view tells you something different. Valuation ratios do the same for companies.

The lesson

Price-to-book (P/B) compares the share price with the company's net assets per share and is often used for banks. Price-to-sales (P/S) compares the company's total market value with its yearly revenue, which helps with companies that are not yet profitable. Dividend yield is the yearly dividend divided by the share price, and an unusually high yield can be a warning that the market expects a cut. No single ratio fits every company, so pick the one that suits the business.

A worked example

Illustrative example: a bank's share costs 150 and its net assets are 100 per share, so its P/B is 1.5 (150 divided by 100). A young company is valued at 500,000,000 with yearly revenue of 100,000,000, a P/S of 5 (500,000,000 divided by 100,000,000). A share at 50 paying a yearly dividend of 2 yields 4% (2 divided by 50 times 100); if the price falls to 25 and the dividend stays at 2, the yield jumps to 8% (2 divided by 25 times 100).

The same idea at four levels

1. Beginner. Different ratios compare the price with different things about a company.
2. Foundation. P/B compares price with net assets per share, P/S compares market value with yearly revenue, and dividend yield compares the dividend with the price.
3. Intermediate. P/B suits asset-heavy businesses such as banks, and P/S suits young companies that do not make a profit yet.
4. Advanced. Dividend yield rises when the price falls, so a very high yield can mean the market expects the dividend to be cut.
5. Expert. Experts match the ratio to the business, compare it with peers and history, and ask why a ratio looks unusually cheap.

Mistakes to avoid

• Chasing a very high dividend yield without asking why the price fell.
• Using one ratio for every type of company.
• Treating a low P/B as a bargain without checking the quality of the assets.

Goal of this lesson: Use price-to-book, price-to-sales and dividend yield alongside P/E.