You like the Corner Bakery’s products. You have read its accounts. Sales are dependable, and you understand how it earns money. Would any purchase price be acceptable?
Imagine buying the whole business. Paying 100 million won and paying 1 billion won are very different transactions. The ovens, staff, and customers can be identical while the amount you need the business to justify changes tenfold.
Finding a good business leaves another task: examining the price attached to it. Every calculation here concerns our fictional bakery, not a target price or buying range for a real stock.
Put earnings beside the share price
The bakery earned 10 million won in the previous lesson. Assume all profit belongs to ordinary shareholders and 10,000 shares remained outstanding throughout the year.
Earnings per share, or EPS, is 1,000 won.
EPS = KRW 10,000,000 of profit ÷ 10,000 shares
At a share price of 10,000 won, the price-to-earnings ratio, or P/E, is 10. Using the whole company gives the same answer: market capitalization of 100 million divided by earnings of 10 million.
Real calculations distinguish profit attributable to ordinary shareholders, weighted-average share counts, and diluted EPS reflecting potential additional shares. The simplified example keeps those complications out of the arithmetic.
P/E describes the relationship between price and earnings. A ratio using reported past earnings differs from one using forecasts, which may not materialize. AMF guide to share valuation ratios
A P/E of 10 does not promise repayment in ten years. That interpretation assumes stable earnings, full distribution to you, and no need to consider reinvestment or the time value of money. A share is not a ten-year repayment contract.
A low P/E can tell two different stories
A company trading at five times earnings looks inexpensive beside one trading at twenty. Perhaps the market has overlooked an opportunity. Perhaps recent earnings are unusually high and unlikely to last.
Imagine a materials producer enjoying a temporary shortage that allows exceptional prices. Investors may expect profits to fall. Dividing a cautious market price by the unusually large current profit produces a low P/E.
The apparent bargain can therefore be partly a feature of the denominator.
A fast-growing company may receive a high multiple because investors expect much larger future earnings. If that growth arrives, the price may prove reasonable. If expectations fail, both forecast earnings and the multiple investors are willing to pay can fall.
| Fixed share price: KRW 10,000 | Assumed EPS | Resulting P/E |
|---|---|---|
| Lower earnings | KRW 500 | 20 times |
| Existing level | KRW 1,000 | 10 times |
| Higher earnings | KRW 1,500 | About 6.7 times |
Price is held fixed to isolate the denominator. This is not a forecast that the market price will remain unchanged.
The reporting period matters. So does the distinction between recurring profit and a one-off gain. For a loss-making company, P/E may be negative or unavailable. A negative ratio should not be ranked as an even cheaper version of a small positive one.
Book value is not a liquidation promise
The bakery ended the year with book equity of 50 million won. With 10,000 shares, book value per share is 5,000 won. A 10,000-won share price produces a price-to-book ratio, or P/B, of 2.
Book equity is assets minus liabilities as measured under the applicable accounting rules. It is not necessarily the cash shareholders would receive if the company were sold today.
A brand or valuable customer relationship may not be fully represented in book value. Conversely, some recorded assets may be difficult to sell or collect at their stated amounts.
A P/B below one invites investigation. It does not automatically establish a protected bargain. Continuing losses can erode equity, and asset quality may disappoint. Negative equity makes conventional interpretation of the ratio particularly difficult.
Industry matters. A business relying on factories and inventory has a different asset structure from a software company. Putting both into a single ranking based on one multiple can hide the differences that explain their valuations.
Ask why return on equity is high
Return on equity, or ROE, compares profit with shareholders’ book equity. A period’s profit is commonly compared with average equity over that period.
The bakery began the year with equity of 40 million won and ended with 50 million. A simple beginning-and-end average is 45 million. Dividing profit of 10 million by 45 million gives an ROE of about 22.2%.
This is not a promised return to someone buying the shares. It describes the relationship between the business’s accounting profit and book capital.
ROE can rise because the business earns more efficiently. It can also rise because borrowing allows the company to operate with relatively less equity. Very small equity can produce an especially dramatic ratio. Read ROE alongside debt and cash flow before concluding that a high figure reflects a safer or better business.
Replace one answer with several possibilities
Valuation can feel like an examination with one exact answer. Yet the inputs are uncertain before the calculation begins.
Try making that uncertainty visible.
| Hypothetical future | EPS | Illustrative P/E | Implied price |
|---|---|---|---|
| Weaker demand and expectations | KRW 700 | 8 times | KRW 5,600 |
| Existing conditions maintained | KRW 1,000 | 10 times | KRW 10,000 |
| Successful expansion | KRW 1,300 | 12 times | KRW 15,600 |
A sensitivity exercise, not probabilities, justified valuation multiples, or trading recommendations.
The middle row is not automatically a target price. The table asks how much the conclusion changes when the assumptions change.
If today’s price is defensible only under the most optimistic case, disappointment has room to matter. The idea of a margin of safety involves leaving room for error, but no chosen discount guarantees protection from loss.
Future money also needs to be evaluated from today’s perspective. You must wait for it, its arrival is uncertain, and other uses for capital exist in the meantime. Higher interest rates or greater perceived risk can reduce the price investors are willing to pay for future earnings. The present-value reasoning from the bond lesson reaches into equities too.
Keep the unknowns visible
Choose a company you are curious about and record its P/E, P/B, and ROE together with the reporting period and data date. If two websites show different values, check definitions before deciding one must be wrong.
One may use forecast earnings and another trailing earnings. They may use different share counts, reporting scopes, or update dates. A precise-looking number can still answer a different question from the one you intended.
Then describe a condition under which the company’s earnings could fall. If nothing comes to mind, that may indicate incomplete research rather than a risk-free business.
You can leave a blank where important information is missing. Waiting is a possible decision when the business, its finances, or the price remains difficult to understand.
The queue outside the bakery is still encouraging. You now have another question to place beside it: how much of that encouraging future is already included in the price?