Is That Stock a Bargain or a Trap?
How do you tell if a stock is a hidden gem or an overpriced trap? Six simple ratios act like a treasure map — and you can read all of them with grade-school division.
Each one compares the stock's price to something real: what the company owns, earns, sells, or pays you.
We'll use a made-up company, XYZ Corp., so you can see the math with easy numbers.
One rule before we start: always compare a ratio to similar companies in the same industry, never across industries.
1. Check the Price Against What It Owns (P/B)
Formula: P/B = stock price ÷ book value per share
Book value is the company's stuff minus its debts — what would be left if it sold everything and paid everyone back.
The price-to-book ratio asks how much you're paying for each dollar of that leftover pile.
Say XYZ trades at $50 and its book value per share is $25: that's a P/B of 2, meaning you pay $2 for every $1 of net assets.
If similar companies sit at 1.5, XYZ looks pricey; below 1 can mean a bargain — or a business in real trouble, so dig deeper.
This ratio works best for asset-heavy businesses like banks and real estate, and our guide to reading financial statements shows where book value lives.
How to Check It:
- StockAnalysis.com — free site listing P/B for any ticker, right on the statistics page.
2. Check the Price Against What It Earns (P/E)
Formula: P/E = stock price ÷ earnings per share
This is the most famous ratio in investing: how many dollars you pay for each dollar of yearly profit.
XYZ at $50 with $5 of earnings per share has a P/E of 10 — you're paying $10 per $1 of profit.
A high P/E means the market expects big growth; a low one means a possible bargain — or a business the market thinks is stuck.
If XYZ's industry averages a P/E of 20, XYZ is either an overlooked deal or the slow kid in class. Your job is figuring out which!
How to Check It:
- Finviz — a free screener that shows P/E for a whole industry at once, so comparisons take seconds.
- Benjamin Graham's classic — Buffett calls it the best investing book ever written
- Teaches margin of safety and the famous Mr. Market parable
- Jason Zweig's commentary ties each chapter to modern markets
3. Check the Price Against What It Sells (P/S)
Formula: P/S = market capitalization ÷ total revenue
Market capitalization is the price tag on the whole company — all its shares added up.
The price-to-sales ratio tells you what you pay per dollar of stuff the company actually sells, which makes it the go-to gauge for young companies that aren't profitable yet.
XYZ with a $500 million market cap and $250 million in yearly revenue has a P/S of 2.
If rivals trade at 3 or 4, XYZ might be cheap — but if its sales are shrinking, even a low P/S won't save you.
How to Check It:
- Compare P/S only among companies in the same business, and always check whether revenue is growing or fading.
4. Check the Price Against Real Cash (P/FCF)
Formula: P/FCF = market capitalization ÷ total free cash flow
Free cash flow is the money truly left over after the company pays its bills and maintains itself — the hardest number for accountants to dress up.
That cash funds dividends, pays down debt, and feeds growth.
XYZ generating $50 million of free cash on a $500 million market cap has a P/FCF of 10 — $10 per $1 of real cash.
Many value hunters like to see this under about 15, so if XYZ's rivals sit at 20-plus, XYZ starts looking tasty.
How to Check It:
- The cash flow tab on StockAnalysis.com — find free cash flow, then divide the market cap by it.
- Time-value-of-money keys solve loans, mortgages, and pension math
- The cash-flow function calculates NPV and IRR for uneven cash flows
- A classroom and exam standard for finance students and professionals
5. Flip the P/E Into a Yield
Formula: earnings yield = earnings per share ÷ stock price (or 1 ÷ P/E)
Flip the P/E upside down and you get the earnings yield — the company's profit as a percentage of what you paid.
Why bother? Because a percentage lets you compare a stock directly to bonds and savings rates.
XYZ's P/E of 10 flips into a 10% earnings yield: every $100 invested generates $10 of company profit.
If Treasury bonds pay roughly 4%, that 10% looks attractive — as long as those earnings hold up or grow.
How to Check It:
- Divide 1 by any stock's P/E, then ask: does this beat what a super-safe bond pays me, by enough to be worth the risk?
6. Count the Cash It Pays You
Formula: dividend yield = annual dividend per share ÷ stock price
A dividend is a slice of profit the company mails to shareholders, and the yield shows that payout as a percentage of the price.
XYZ paying $2 a year on a $50 stock yields 4% — $4 of income per $100 invested.
Income lovers cheer a fat yield, but be careful: a sky-high yield can mean the market expects the payout to be cut.
A dividend is only as good as the profits behind it.
How to Check It:
- Check the "payout ratio" — the share of profit spent on dividends; near or above 100% means the dividend is living on borrowed time.
Wrapping Up
These six ratios are a financial X-ray: point them at any stock and the hype fades, leaving the bones — what it owns, earns, sells, and pays.
No single ratio decides anything; it's the pattern across all six, next to similar companies, that tells the story.
These are ideas to practice with, not personal instructions or individualized financial advice — your money, your call.
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