Saying one share costs 20 euros and another 300 euros does not tell us which is “more expensive”. The price of an individual share, taken alone, is almost meaningless: it depends on the number of shares outstanding and corporate actions such as share splits and reverse splits. To understand whether the market assigns a high or low valuation to a company, we must relate that price to what the business produces: earnings, equity, cash flows, expected growth and risk. This distinction matters because, in everyday language, an “expensive share” often means a share with a high unit price. In finance, the question is different: how much am I paying today for each euro of the company's earnings or equity? Here too, no magic indicator exists. A stock may look expensive under one multiple and attractive under another, or appear cheap simply because the market expects earnings to fall.
Share price and company value
Imagine two companies. The first has 1 million shares worth 100 euros each; the second has 100 million shares worth 2 euros each. The first is worth 100 million on the stock market, the second 200 million. Although each share in the first costs fifty times more, the company as a whole is worth half as much. The first useful number is therefore market capitalisation: share price multiplied by the number of shares outstanding. But market capitalisation alone also cannot establish whether a stock is good value: it must be compared with the company's results and prospects.
P/E: useful, but much less conclusive than it seems
One of the most widely used indicators is Price/Earnings, or P/E, defined by Borsa Italiana as the ratio of share price to earnings per share, equivalent to market capitalisation divided by company earnings. If a share trades at 50 euros and earnings per share are 5 euros, P/E is 10. If it trades at 100 with the same earnings, P/E rises to 20. It is tempting to conclude that P/E 10 is “cheap” and P/E 20 “expensive”, but the comparison makes sense only alongside growth and risk. A stable company with no growth may warrant a lower multiple; a business able to increase earnings rapidly may command higher multiples because the market is paying for future results not yet fully reflected in its current accounts.
P/E also has clear limitations. If earnings are temporarily depressed, the ratio can become very high without the stock necessarily being overvalued. If the company is loss-making, P/E may become almost meaningless. Accounting earnings also depend on depreciation, amortisation, provisions and other accounting choices.
Comparisons must be like-for-like
Suppose a bank has a P/E of 9 and a technology company a P/E of 30. Automatically concluding that the bank is better value would be superficial. The sectors may have very different financial structures, growth, profitability and risks. Multiples work better when comparing companies with similar sectors, business models and prospects. Even within a sector, we need to understand what lies behind the number. Two companies with P/E 12 can be very different if one grows by 2% annually and the other by 15%, or if one has substantial debt and the other a strong net cash position.
Price/Book Value: how much am I paying relative to equity?
Another common indicator is Price/Book Value, or P/B, which compares market value with book equity. If a company has equity of 500 million and market capitalisation of 750 million, P/B is 1.5. This indicator is particularly intuitive in sectors where book equity has strong economic significance, but may be less informative for businesses whose value depends on brands, software, networks, human capital or other resources not always fully represented on the balance sheet. A value below 1 therefore does not automatically signal a bargain: the market may expect future losses, asset write-downs or structurally low profitability.
Look at cash flows too
Borsa Italiana also refers to multiples relating price to cash flows. The reason is simple: accounting profit is not the same as cash generated. A company can report high profit while absorbing liquidity, for example because trade receivables or the investment needed to maintain operations are increasing. Many analysts therefore examine free cash flow, the cash remaining after accounting for investment required by the business. If a company is worth 1 billion and consistently generates 100 million in free cash flow, its value-to-cash-flow ratio is very different from that of another company worth the same amount but producing only 20 million.
A short valuation exercise
Imagine two companies in the same sector. Alfa has market capitalisation of 600 million, profit of 50 million and free cash flow of 35 million; Beta has market capitalisation of 900 million, profit of 60 million and free cash flow of 80 million. Alfa's P/E is 12, Beta's 15: looking only at this multiple, Alfa appears cheaper. But market capitalisation divided by free cash flow is approximately 17 for Alfa and just over 11 for Beta. The second measure changes the interpretation because Beta converts a much larger share of its earnings into cash. This does not automatically make Beta the better investment. We must understand why Alfa generates less cash: perhaps it is building a facility that will increase production capacity, or customers are paying more slowly. Likewise, Beta may have temporarily reduced investment, improving current cash flow at the expense of future growth. Multiples highlight a difference; financial statement analysis must explain it.
Growth: the element that changes everything
Imagine two companies each currently earning 10 million. The first is worth 100 million, giving P/E 10; the second is worth 200 million, giving P/E 20. But if the first has stagnant earnings while the second grows at 20% annually, the picture may reverse after a few years. The problem is that future growth is an estimate, not a certainty. The more a valuation depends on distant results, the greater the risk that small changes in expectations cause large price movements. This is why growth stocks may react sharply to revisions in expected earnings or interest rates.
A stock can fall 50% and still be expensive
This is a common psychological mistake. A share falling from 100 to 50 euros does not automatically become attractive. If expected earnings simultaneously collapse from 5 to 1 euro per share, P/E rises from 20 to 50: the stock costs half as much in absolute terms but is more expensive relative to earnings. The reverse is also true: a share can rise substantially and remain reasonably priced if earnings and cash flows grow faster than its price. A historical price chart alone therefore cannot establish value.
Debt cannot be ignored
Two companies may have the same market capitalisation and net profit but very different debt levels. Debt affects risk, interest payments and the ability to withstand downturns in the economic cycle. Comparing businesses with different financing structures often involves measures based on Enterprise Value, which considers the value of the entire operating business, including the effect of its net financial position. Without excessive formulas, the principle is simple: I cannot value a company by looking only at its equity value if a huge portion of its operations is financed by debt that must be serviced and repaid.
The method I would use
To decide whether a share deserves further investigation, I would start with the business and financial statements, not the chart. I would examine revenue and earnings growth, margins, cash-generating ability, debt, returns on capital and the durability of competitive advantage. Only then would I compare valuation with similar companies and the company's own history, using several indicators rather than just one. Finally, I would construct scenarios. If earnings grow less than expected, does today's price still make sense? What if margins fall? What if the cost of capital rises? A valuation is not a snapshot precise to the cent: it is a range dependent on assumptions. The question is therefore not simply “does this stock have a low P/E?”, but “what future results must I assume to justify today's price?”. When the answer requires a perfect scenario, there is little room for error. When the price remains reasonable under cautious assumptions, the analysis becomes more interesting.
Value and price do not coincide to the cent
A sound valuation normally produces a range, not an exact number. If we estimate a business to be worth between 80 and 100 euros per share, a price of 78 may offer a limited or attractive margin of safety depending on the reliability of the assumptions. A price of 95 is not necessarily “expensive”: it may fit the central scenario. The problem arises when justifying 120 euros requires perfect growth, rising margins and no surprises. I would therefore always distinguish three scenarios: cautious, central and favourable. I would vary revenue growth, margins, necessary investment and the cost of capital, observing how the resulting value changes. If a small adjustment makes the valuation unstable, the stock depends heavily on expectations. If it remains reasonable under conservative assumptions, the analysis is more robust. Attractiveness is not a fixed property of a share: it depends on the price paid and the uncertainty of future results.
Note. This article is for information and educational purposes only. It does not constitute an investment recommendation or an invitation to buy or sell financial instruments.