• Distinguishing between market price and intrinsic value
  A stock is considered attractively valued when its market price is below what the company should be worth based on fundamentals. This theoretical fair value is referred to as intrinsic value or fair value. The market price is the current share price determined by supply and demand on the stock exchange. If the intrinsic value of a stock is higher than its market price, the stock is regarded as undervalued and is typically seen as a potential buying opportunity. Conversely, a stock is considered overvalued when the market price is significantly higher than the level justified by its intrinsic value.
• Example and core principle
  Assume a detailed analysis results in an intrinsic value of EUR 50 per share, while the current market price is EUR 40. In this case, the market assigns a lower value to the stock than the fundamentals would suggest. The stock appears undervalued. An investor may position for rising prices if the market recognises this mispricing and the share price moves towards fair value. The opposite is true if the intrinsic value is EUR 40 and the share trades at EUR 50. In that case, investor expectations exceed what can reasonably be supported by the company’s fundamentals. This principle of price versus value is at the heart of the value investing approach that goes back to Benjamin Graham, the mentor of Warren Buffett. Graham coined the term margin of safety. Investors should preferably buy stocks whose market price is significantly below the estimated intrinsic value in order to maintain a buffer for potential errors in their assessment.
• Why deviations are normal
  In day-to-day markets, market price and intrinsic value almost never match exactly. Markets tend to overshoot in both directions. Optimistic growth expectations may lead investors to pay substantially more for a stock than current fundamentals justify. In other situations, pessimism may cause investors to avoid a company, pushing its share price below fair value. The objective for disciplined investors is to identify such mispricings. Ideally, a stock is cheap when market sentiment is pessimistic and the share is trading below its intrinsic value. It is expensive when excessive optimism drives the price above a level justified by fundamentals.

To assess whether a stock is cheap or expensive, investors and analysts often rely on established valuation multiples. Two of the most widely used are the price-to-earnings ratio (P/E) and the price-to-book ratio (P/B). These indicators provide a quick and comparable view of how the market values a company. However, they must always be interpreted in context. A low multiple on its own is not a guarantee of an attractive investment.

• P/E ratio (price-to-earnings ratio)
  The P/E ratio relates the share price to earnings per share. It is calculated by dividing the current share price by the company’s earnings per share for a given year. A simple example: If a share trades at EUR 100 and the company generates earnings per share of EUR 10, the P/E ratio is 10.

  In principle, the lower the P/E ratio, the cheaper the stock appears in relation to its earnings. A low P/E ratio, for example below 12, is often seen as a potential indicator of undervaluation, while a very high P/E ratio, for example above 30, may point to overvaluation. However, comparisons must always be made within the relevant sector. Different industries exhibit structurally different P/E levels.

  For instance, a P/E of 15 may be considered expensive for a bank, whereas a technology company with a P/E of 15 might be viewed as attractively valued. In the technology sector, double-digit P/E ratios are often normal or even low, while utilities or insurance companies frequently trade on single-digit P/E levels. Investors should therefore always compare a stock with its direct competitors and with its sector before drawing conclusions.

• P/B ratio (price-to-book ratio)
  The P/B ratio compares the share price with the book value per share. Book value equals the company’s equity divided by the number of shares. Simplified, it represents the accounting substance per share, for example buildings, machinery and cash, less liabilities.

  A P/B ratio of 1.0 means that the market price matches the accounting value. A P/B ratio below 1.0 can be a sign of undervaluation. A historical example is Credit Suisse, whose shares at times traded at a P/B ratio of around 0.06. Many investors believed they had found a bargain. However, this also highlights the risk: An extremely low P/B ratio can indicate that confidence in the company’s future is severely impaired. In the case of Credit Suisse, these concerns were justified and the supposed bargain turned out to be a value trap as the bank ultimately failed.

  The conclusion is that a low P/B ratio can be attractive, but investors must understand why the market is assigning such a deep discount to book value. There are often fundamental reasons for this.

• Additional indicators
  Alongside P/E and P/B, investors use other metrics depending on their investment approach to differentiate between cheap and expensive stocks. Frequently used measures include earnings yield (earnings divided by price), dividend yield (dividend divided by price) and return on equity (RoE) as an indicator of profitability. The level of leverage, typically measured as debt-to-equity, is also important. A moderate level of debt is generally viewed positively, while high leverage increases vulnerability.

Experienced investors analyse several indicators in combination. They compare P/E, P/B and yield metrics with sector averages, review trends in financial data over recent years and assess the company’s outlook. This broader perspective provides a more robust view of whether the current share price is cheap or expensive relative to the underlying value.

In addition to simple valuation multiples, investors use fundamental valuation methods to estimate the intrinsic value of a stock as accurately as possible. These methods can broadly be divided into two categories: Asset-based approaches and income-based approaches.

• Net asset value (NAV)
  This method determines the intrinsic value of a stock based on the company’s underlying assets. It focuses on tangible items such as property, machinery, patents and cash, minus liabilities. The book value used in the P/B ratio is one form of net asset value.

  However, balance sheets do not always capture all relevant assets. Intangible assets such as strong brands, patents or software can be highly valuable but may only be partially reflected in financial statements. As a result, a company may have a low book value yet still be highly valuable due to its intangible assets.

  There is also a risk that goodwill and intangible assets recorded on the balance sheet are overstated, especially after costly acquisitions. These values must therefore be interpreted with caution. Net asset value provides a baseline, but it should be complemented by qualitative assessments.

• Income-based valuation and the DCF method
  More important for equity valuation is the focus on a company’s future cash flows. The most widely used approach is the discounted cash flow (DCF) model. The DCF method estimates the intrinsic value by forecasting expected future cash flows and discounting them to their present value. The underlying idea is straightforward: The current value of a stock depends on the future cash flows the business can generate.

  If the calculated DCF value is above the current share price, the stock is seen as undervalued. If it is below the market price, the stock may be overvalued. The quality of a DCF valuation depends heavily on the assumptions used, such as growth rates, profit margins and the cost of capital. There is therefore no single correct value, only an estimate based on scenarios. Nevertheless, both professional investors and corporate decision-makers use this approach extensively.

In practice, both asset-based and income-based methods are combined. Many analysts begin with balance sheet analysis to determine a lower bound for the company’s value and then complement this with a DCF valuation to capture earnings potential. This creates a valuation corridor for what the stock may be worth. It is essential to consider multiple scenarios to understand how sensitive intrinsic value is to changes in economic conditions, competition or other external factors.

• Peer group comparison
  As with P/E ratios, a company’s valuation must always be interpreted in context. Firms from different sectors exhibit structurally different valuation levels. High-growth technology companies often trade at higher P/E and P/B ratios because investors expect strong future earnings. Utilities or banks, by contrast, typically trade at lower multiples.

  There are also regional differences. For many years, US equities, particularly in the technology sector, have traded at higher valuation levels than comparable stocks in Europe or emerging markets. These differences reflect varying growth expectations, risk premia and market structures. Investors should therefore ensure that comparisons are made within the appropriate peer group, focusing on direct competitors, sector averages and, where relevant, similar regional markets.

• Considering intangible assets
  In today’s economy, intangible assets play an increasingly important role. Examples include brand strength, patents, data, software and customer relationships. These factors can create significant value but are often only partially captured by traditional accounting and valuation metrics.

  A company with substantial research and development activity or with valuable patents may appear expensive based on traditional measures, even though its innovation potential supports a higher intrinsic value. At the same time, intangible assets entail risks. If a large portion of a company’s value rests on goodwill or brand-related assets, this value can decline rapidly if expectations are not met.

  It is also important to note that goodwill is an intangible asset, not a synonym for book value. For companies with substantial intangible assets, investors should analyse how these values were created, whether organically or through acquisitions, and how sustainable they are.

• Leverage and capital structure
  Financing decisions also have a significant impact on valuation. Higher interest expenses reduce profits, which increases the P/E ratio if the share price does not decline. In practice, however, heavily leveraged companies often experience a larger drop in share price as market expectations deteriorate. This can result in a seemingly low P/E ratio. The same applies to P/B ratios: when equity declines, the P/B ratio increases unless the share price falls more sharply. Low P/B ratios often arise when the market has already priced in higher risks.

  For this reason, leverage and the interest rate environment must always be considered when evaluating valuations. Metrics that capture the entire capital structure, such as enterprise value to EBITDA, as well as credit quality and liquidity assessments, provide additional insight.

• When “cheap” is not genuinely cheap
  One common risk is the so-called value trap. This refers to stocks that appear attractively valued based on fundamental metrics but are in reality structurally challenged. Typical reasons include long-term headwinds in the industry, outdated business models, declining profit margins or weak management. Investors who rely solely on valuation multiples may overlook these issues and misinterpret the low valuation as an opportunity.
• Assessing quality and catalysts
  To avoid value traps, it is not sufficient to focus only on numbers. Qualitative factors also matter, such as competitive positioning, product pipeline, innovation capabilities, margin development and a credible strategic plan. It is equally important to look at potential catalysts that could drive a revaluation, including new products, strategic shifts, spin-offs or share buybacks. Without such catalysts, an undervalued stock may remain undervalued for an extended period.
• Incorporating momentum and sentiment
  Modern quantitative approaches often integrate momentum. Stocks with persistently negative price trends should be approached with caution, even when they appear fundamentally cheap. A strong downward trend may serve as a warning signal. Conversely, stabilising price behaviour can indicate that the market is not fully discounting the company’s prospects.
• Interim conclusion
  The key challenge is to distinguish fundamentally sound undervalued stocks from companies that only appear cheap at first glance. In addition to valuation metrics, investors must assess business quality and market sentiment.

• Two types of investors, one common objective
  Both active traders and long-term investors need to understand whether a stock is attractively valued or overvalued. For active investors, valuation metrics and models can help identify temporary mispricings. Long-term investors, by contrast, use valuation as a core element of their decision-making. Their objective is to identify stocks whose market price is significantly below fair value in order to benefit as this gap closes over time. The principle can be summarised as: Buy one dollar, but do not pay more than 50 cents.
• Valuation as a foundation of investment strategy
  For professional asset managers, valuation plays an important role in equity selection and portfolio allocation. In multi asset portfolios, equity exposure is partly determined by whether markets appear overvalued or undervalued. Within equity strategies, systematic valuation models filter stocks based on metrics such as P/E, P/B, leverage and other factors. Private investors can adopt a similar approach. No single metric can predict future price developments with certainty, but valuation metrics provide important guidance.

A stock is generally attractively valued when its intrinsic value, derived from asset- and income-based analysis, exceeds its current market price. In practice, this is often reflected in low valuation multiples relative to the peer group and in solid fundamental data. A stock is considered overvalued when the market price exceeds the calculated intrinsic value, typically visible in very high multiples and ambitious expectations priced into the share.

Looking at one or two metrics is not sufficient. What matters is a holistic approach:

• Compare valuation metrics in context
  This includes sector, region and historical benchmarks to identify meaningful deviations.
• Review business model quality and balance sheet strength
  This includes assessing leverage, liquidity and the relevance of intangible assets.
• Estimate a personal fair value
  Where possible, this should be supported by simplified discounted cash flow considerations.
• Recognise warning signals
  Persistently falling prices despite low valuation metrics require further investigation to understand the underlying causes.
• Identify opportunities
  Stocks that are overlooked or out of favour but supported by solid fundamentals can offer potential.

A stock’s valuation is best determined by comparing its market price with its intrinsic value, taking into account relevant metrics and contextual factors. If the intrinsic value is meaningfully above the market price, the stock may be attractive. If it is significantly below the market price, caution is warranted.

The key is to rely on disciplined, evidence-based criteria rather than on intuition. Investors who adopt a structured valuation process can assess opportunities more effectively. A global, factor-based equity solution that integrates value and size with quality filters applies these principles consistently across markets. Learn more