When you read articles about investing, you will frequently come across ratios like P/E or words like market capitalization. Here’s a quick primer on what they all mean and their significance. Please note that this list is not in alphabetic order since some of the definitions refer to previous definitions.
Market Capitalization: This is how much the company is worth. Market capitalization is the number of shares outstanding times the price of the share. So if a company has 10 million share float and each share is $50, the company is worth $500 million.
Enterprise Value: This is the company’s market capitalization plus its net cash. It is how much cash it would take to buy the company and pay off all of its debts. For example, in the example above, the company’s market capitalization was $500 million because it had 10 million shares at $50 a share. Let’s say that company also has $300 million in debt and $50 million cash. In this case, the company’s enterprise value is $750 million.
If a company’s market cap is $500 million, it has $300 million in cash and no debt, then its enterprise value is just $200 million.
P/E (Price To Earnings): This is ratio of the company’s stock price (P) divided by the companies earnings (E). In short, this is how many years it would take for the company to make money to equal its market capitalization. The average P/E is generally around 15 or so. Be careful of using P/E too much. A company’s earnings can fluctuate greatly, especially during an oddball period like a recession or a boom.
P/S (Price To Sales): This is the company’s price divided by its revenues. This is another factor people use to tell if a company is overvalued or not. P/S is more helpful when P/E is off due to extraneous circumstances.
EBITDA (Earnings before interest, taxes, depreciation, and amortization): This is earnings with those four factors stripped out. Helpful when earnings may be off if one of those four factors is higher than usual.
PEG (price/earnings divided by growth): This is the company’s price divided by growth rate. Made famous by Peter Lynch, people such as Jim Cramer say you shouldn’t buy a growth company for more than 2 times growth rate. So if a company is growing at 20% yearly, you shouldn’t buy it for more than a 40 P/E. PEG is not useful for companies with small or flat growth. After all, it’s silly to assume a company is overpriced with a P/E of 2 if its growth rate is 1%.