Valuation 101: P/E, ROE, and cash flow
How to read the most important fundamental ratios and avoid the classic traps.
By MarketPulse Editorial · 2/1/2026 · 10 min read
Valuation tries to answer one question: is this price reasonable for what the company actually earns?
Price-to-earnings (P/E). Share price divided by earnings per share. A P/E of 25 means investors are paying ₹25 today for each ₹1 of last-year's earnings. P/E is useful for comparison between similar companies *in the same sector*. A bank with P/E 8 and a software firm with P/E 35 aren't necessarily mispriced — they have different growth and capital structures.
Return on Equity (ROE). Net income divided by shareholders' equity. ROE tells you how efficiently the company turns invested capital into profit. A consistent 20%+ ROE in a non-cyclical sector is a strong signal of quality — but watch for leverage: ROE can be artificially high if the company borrows heavily.
Free Cash Flow (FCF). Operating cash flow minus capital expenditures. FCF is "the money you could actually take out of the business this year". It's much harder to fake than reported earnings. A business with stable, growing FCF tends to be a durable business.
Classic traps. - Cheap-by-P/E stocks are often cheap for a reason: declining business, regulatory overhang, or accounting issues. - High ROE financed by debt looks great until the rate cycle turns. - Earnings can be smoothed; cash flow is harder to dress up.
Use multiple ratios together, compare to sector peers, and read the management discussion section of annual reports. Build a story for why the business will be worth more in five years — then check that the price you're paying reflects that story.
Educational only — not investment advice. Consult a licensed professional.
Educational only — not financial advice. Educational only — not financial advice. Markets are risky. Consult a SEBI-registered investment adviser or licensed financial professional before investing. Read full disclaimer.