There are two broad approaches: compare the asset to similar ones (relative valuation), or estimate the cash it will produce and discount that back to today (intrinsic valuation). Both are useful. Neither is precise.
The P/E ratio
P/E = share price ÷ earnings per share. It is often described as the number of years of current earnings you are paying for. A P/E of 20 means paying £20 for every £1 of annual profit.
The critical insight is that a P/E is not a verdict — it is a question. A high P/E means the market expects growth. A low P/E means the market expects trouble. The useful work is deciding whether that expectation is right.
| Situation | Naive reading | Better question |
|---|---|---|
| P/E of 8 | Cheap — buy | Why so low? Declining industry? Debt? Earnings about to fall? |
| P/E of 45 | Expensive — avoid | What growth is implied, and is it plausible? |
| No P/E (loss-making) | Uninvestable | Is it investing for growth, or simply not working? |
Other multiples
- P/B (price to book) — price against net asset value. Meaningful for banks and asset-heavy businesses, nearly meaningless for software companies whose value is people and code.
- EV/EBITDA — enterprise value against earnings before interest, tax, depreciation and amortisation. Useful for comparing companies with different debt levels, because enterprise value includes debt.
- P/S (price to sales) — the fallback when there are no earnings. Weak, because sales without a path to profit are not worth much.
- PEG — P/E divided by growth rate. A rough attempt to make high-growth and low-growth companies comparable. Treat as a sanity check, not a valuation.
Discounted cash flow, conceptually
A DCF estimates every pound of cash a business will generate in future, then discounts each one back to today's value — because £100 in five years is worth less than £100 now.
The discount rate reflects both risk and the return available elsewhere. This is exactly why interest rates move asset prices: raise the discount rate and every future cash flow is worth less today. Long-duration assets — high-growth companies whose profits sit far in the future — fall hardest, which is why they sell off most sharply when rates rise.
Reverse the model
The most practical use of valuation for a trader is backwards. Instead of asking “what is this worth?”, ask “what does today's price assume?”
If a share price only makes sense assuming 25% annual growth for a decade, you have a clear, falsifiable question to research: has any comparable company ever done that? Is the market it sells into even large enough? That is a far more tractable question than conjuring a price target from nothing.
Valuing other asset classes
| Asset | Anchor | Difficulty |
|---|---|---|
| Stocks | Discounted future cash flow | Hard but well-defined |
| Bonds | Contractual coupons and principal | The most tractable — the cash flows are fixed |
| Currencies | Relative rates, inflation, purchasing power | Relative only — there is no absolute value |
| Commodities | Marginal cost of production, inventories | Supply and demand, not cash flow |
| Gold | No cash flow at all — real yields and confidence | Priced by what else is on offer |
| Crypto | Network activity, supply schedule, liquidity | No agreed framework exists |