You can pull ratios from figures in the accounts, or you can find them made up for you in any newspaper or on financial websites and software. They enable you to value companies on fundamentals against their own past and their peers. But if the same ratio for two companies was calculated differently, the differences must be reconciled to make a like-for-like comparison. Let us now look at some key ratios.

Earnings per share
The earnings per share (EPS) is a measure of the company’s profitability. It is the profit attributable to the ordinary shareholders (ie profit before ordinary dividends) divided by the number of ordinary shares in issue during the year. The City looks for an EPS that rises steadily, even if slowly, year by year, and rewards companies that can demonstrate it.

Listed companies are required to disclose two measures of EPS, basic and diluted, on the front of the profit & loss account. The diluted EPS figure adjusts the basic EPS figure to show what the result would have been had all potential ordinary shares (such as employee share options and convertible debt) been converted into shares.

Companies can also provide an adjusted EPS figure but in the notes to the accounts and not on the face of the profit & loss account. The adjusted figure may show earnings before items that the directors prefer to exclude.

Price/earnings ratio
The price/earnings ratio is the share price divided by earnings per share. It is how the market rates a stock and shows how many years it will take the company, at the applicable rate of earnings, to earn the equivalent to its market value.

If the company’s P/E ratio is low compared with that of its peers, the shares are looking cheap. They could be good value, but are very likely to be depressed for a reason.

If the company’s P/E ratio is high compared with that of its peers, the shares are looking expensive, but it could be for a good reason.

The historic P/E is listed in the newspapers and, to find the sector and market averages for comparison purposes, you should look at the FT’s Actuaries Share Indices (The UK Series) in Monday’s Financial Times.

The prospective P/E is more up to date than the historic figure because it is based on the future analysts’ earnings forecasts, but is also less reliable because they can be wrong.

The P/E ratio can tell you something about the broader market. In the five years to mid-2006, the P/E ratio steadily fell in Britain but French and German P/E ratios ended up slightly higher, according to analysts. The Times said in a leading article on 3 July 2006 that a growing gap between the UK and its European competitors had to raise serious questions about how the market was judging the British economy.

The P/E ratio has limitations. It does not take account of a company’s earnings growth, which is important for small companies.

A PEG to hang your valuation on
The price/earnings growth ratio, known as PEG, redresses the balance by combining an assessment of growth with the P/E ratio, and is used to value small growth companies. The ratio is calculated, either on an historical or prospective basis, as the P/E ratio divided by the average growth rate of earnings per share.

Investment guru Jim Slater has advocated a PEG of well under 1 as a criterion for selecting growth. If a company has a prospective P/E ratio of 10 and earnings per share growth of 20 per cent, the PEG ratio is 10 divided by 20, which is 0.5 and, on Slater’s criterion, very attractive. A stock with a prospective P/E of 30 and earnings per share growth of 15 is on a PEG of 2, which he finds too high.

Net assets
To value property companies, investment trusts or composite insurers, use the share price/net asset value (NAV) per share. This is the company’s total assets less its liabilities, debentures and loan stocks, divided by the number of shares in issue.

If a company is trading on a low share price/NAV, it may be a bargain, or have problems that are not easily resolvable and that make it a poor investment.

Check how the net asset figure is made up. Properties historically valued on the balance sheet may be worth more because of subsequent capital gains. Machinery may be valued too low owing to a conservative depreciation policy.