December 2025
Issue 8
RATIONAL REFLECTIONS By Bell Institutional
The Shortcomings of Using Ratios in Valuation The best time to use a valuation ratio to value the market — or any company within it — is very rarely, or better yet, never. Valuation ratios such as price-to-earnings (P/E), price-to-book (P/B), or enterprise value to EBITDA (EV/EBITDA) are ubiquitous in finance and promise a quick verdict on “cheap” or “expensive.” Yet, they often deliver optical illusions. At its core, a valuation ratio is nothing more than the market’s embedded expectations divided by a single, noisy accounting denominator. It cannot substitute for the disciplined forecasting of growth, reinvestment needs and risk — the foundational pillars of discounted cash flow (DCF) valuation.
Relative Valuation is Pervasive Relative valuation dominates Wall Street and the investing public. In our view, approximately 90% of equity research reports from Wall Street firms rely on valuation ratios (multiples), and more than 70% of merger and acquisition (M&A) activity uses similar rules of thumb. Multiples are not only common, but also often drive final investment decisions and the price targets investors see on TV. To perform relative valuation, one must: 1. Identify comparable assets and obtain their market prices. 2. Convert these prices into standardized multiples (absolute prices cannot be compared). 3. Compare the target asset’s multiple to those of peers. 4. Conclude whether the asset is overvalued or undervalued. Why is relative valuation so pervasive? It is fast, forgivable, and frictionless — the investing equivalent of fast food. Anyone can do it!
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