Many new investors think stock analysis is extremely complex — dozens of ratios, hundreds of pages of financial reports. In reality, just 3 numbers can help you screen out the majority.
1. P/E (Price to Earnings)
This tells you how much you are paying for every dollar of profit the company generates. A P/E of 15 means you pay 15 dollars to earn 1 dollar in profit.
How to Read P/E Correctly
- Compare within the sector, not in absolute terms. A P/E of 20 in the tech sector is normal. A P/E of 20 in the steel sector is expensive.
- Watch the P/E trend: a declining P/E means the market is growing more pessimistic. Rising P/E means higher expectations.
- Combine with growth: P/E of 25 + 30% annual growth = potentially fine. P/E of 25 + 5% growth = overvalued.
Common trap: "Low P/E means cheap" — Wrong. A P/E of 5 usually means the market does not believe in the company's future, not that it is a bargain.
2. ROE (Return on Equity)
This measures how much profit the company generates from shareholders' equity. An ROE of 20% means that for every 100 invested, the company generates 20 in annual profit.
| ROE | Assessment |
|---|---|
| < 10% | Poor — capital is not being used efficiently |
| 10 — 15% | Average |
| 15 — 20% | Good |
| > 20% | Excellent — the company has a competitive advantage |
Important: look at ROE over 3 consecutive years, not just one year. A sudden spike in ROE could be due to asset sales, not core business performance.
3. Debt/Equity (D/E Ratio)
This shows how much the company borrows relative to its own capital. A D/E of 0.5 means for every 100 in equity, the company has borrowed an additional 50.
| D/E | Risk Level |
|---|---|
| < 0.5 | Very safe |
| 0.5 — 1.0 | Safe |
| 1.0 — 2.0 | Caution — check sector norms |
| > 2.0 | High risk |
Exception: In banking, D/E ratios of 10-15x are normal because of the nature of the business. Always compare D/E within the same sector.
Combining the 3 Numbers
When you combine all three metrics, you get the full picture:
- Low P/E + High ROE + Low D/E = Promising candidate — dig deeper
- High P/E + Low ROE + High D/E = Red flag — avoid
- Fair P/E + High ROE + High D/E = Potential, but leverage risk exists
Simple rule: PEG ratio = P/E divided by the earnings growth rate (%). PEG < 1 = attractive. Example: P/E of 22 with 23% growth gives a PEG of 0.96 < 1 — still reasonable despite a seemingly high P/E.
Quick Check with AI
Want to see these 3 numbers for any stock? Ask FinStock: "Fundamental analysis of [ticker]" — AI returns P/E, ROE, and D/E with an industry comparison in seconds.
See also: Stock Screening from A to Z.