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How to quickly value a company: P/E, P/S and FCF yield as the first filter
Key takeaways
- P/E, P/S and FCF yield are a first filter for quickly valuing a company — they do not replace deeper analysis, but they save time.
- P/E only makes sense when compared within the same sector and against the company's own historical average.
- P/S is valuable for loss-making or fast-growing companies where P/E does not work.
- FCF yield works with real cash, not accounting profit — it is harder to manipulate and value investors prefer it.
- Low valuation multiples are a starting point for the question "why?" — not an automatic buy signal.
Why a quick valuation makes sense
A detailed financial model of a company can take dozens of hours. But before you enter such an analysis, you need to know whether it is worth it at all. That is exactly what quick valuation multiples are for — P/E, P/S and FCF yield. It is not a final verdict, but a first filter: does the price look reasonable at first glance, or is the company clearly overpriced or undervalued? Only then does it make sense to go deeper.
P/E: the classic that has limits
Price-to-Earnings (P/E) is the ratio of the share price to earnings per share. It tells you how much you pay per unit of the company's profit. A P/E of 20 means you pay 20 units of currency for 1 unit of annual earnings — in other words, at constant earnings, the investment would pay back in 20 years.
But P/E's limits are significant. Earnings can be manipulated (accounting choices, one-off items). P/E is worthless for loss-making companies. And comparing P/E across different sectors is like comparing the price of an orange to a tractor. Always compare P/E within the same sector and against the company's own historical average.
P/S: the lifesaver for loss-making companies
Price-to-Sales (P/S) is the ratio of market capitalisation to revenue. It is useful for companies in the growth phase that are not yet profitable — technology start-ups, biotechs or companies undergoing restructuring. A P/S of 5 says you pay 5 units of market value for every 1 unit of revenue.
- Advantage: it does not depend on profitability — usable even for loss-making companies.
- Disadvantage: revenue says nothing about profitability — a company with P/S 2 may be excellent or a disaster, depending on the margin.
- Use: as a comparative tool within a sector and to track trends over time.
FCF yield: the favourite of value investors
Free Cash Flow Yield (FCF yield) is the ratio of free cash flow to market capitalisation. It tells you how much real cash the company generates per unit of invested market value. Unlike P/E, it works with cash, not accounting profit — so it is harder to manipulate.
An FCF yield of 6% means the company generates 6 cents of real cash per unit of market value. The higher the yield, the cheaper the company (given equal quality). Value investors Warren Buffett and Mohnish Pabrai rank FCF yield among their primary metrics.
How to use them as a system
A practical approach: first identify the sector the company operates in and the average P/E and FCF yield for comparable companies. Then compare where the company in question stands — is it significantly above or below the average? If it is below average, ask why — is it an opportunity or a trap? This process gives you the first outline of the situation in 10–15 minutes.
For a deeper dive into value investing I recommend the book review section or reading why active stock picking usually loses to the index. Company analyses can be found in the analysis section.
FAQ
What P/E is considered "normal"?
It depends on the sector and era. The historical average of the S&P 500 is around 15–18. High-growth tech companies may trade at P/E 30–50. Always compare against the sector average and the company's own historical P/E.
Why do investors prefer FCF over accounting profit?
Accounting profit can be influenced by legal accounting choices (depreciation, provisions, capitalisation of costs). Free cash flow is the real movement of cash — harder to "improve" and better reflects the true economics of the company.
How do I find a company's FCF yield?
Free cash flow (FCF) is generally in the cash flow statement as Operating Cash Flow minus Capex. Divide by market capitalisation and you get FCF yield. Screeners such as Finviz, Tikr or Simply Wall St calculate it automatically.