Deep Dive: How to Value a Stock — P/E, EV/EBITDA, DCF and the Metrics That Actually Matter

The price-to-earnings ratio divides a company's share price by its earnings per share. It answers a simple question: how many years of current earnings would it take to pay back the stock price? A stock trading at $264.58 with EPS of $7.91 — as Apple does today — has a P/E of 33.5x. At Microsoft's price of $397.23 and EPS of $15.98, the P/E drops to 24.9x. At Coca-Cola's $79.84 with $3.04 in EPS, the ratio is 26.3x.

The P/E ratio's popularity comes from its simplicity, but that simplicity hides important limitations. Earnings are an accounting construct — they include non-cash charges like depreciation and amortization, stock-based compensation, and one-time write-downs that may not reflect actual cash generation. A company can report low earnings (and a high P/E) while generating enormous cash flow, or report high earnings inflated by accounting choices.

The most common mistake investors make is comparing P/E ratios across industries. A utility company at 15x earnings and a tech company at 35x earnings are not comparable — the tech company may be growing revenue at 20% annually while the utility grows at 3%. What matters is the P/E ratio relative to the company's growth rate, competitive position, and capital intensity. This relationship between price, earnings, and growth is captured by the PEG ratio (P/E divided by the expected earnings growth rate), where a PEG below 1.0 historically suggests a stock may be undervalued relative to its growth prospects.

Enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization) solves the P/E ratio's biggest flaw: it accounts for a company's debt. Enterprise value equals market cap plus total debt minus cash. EBITDA strips out financing decisions and non-cash charges to approximate a company's core operating profitability.

Consider two companies with identical $10 billion market caps. Company A has no debt and $2 billion in cash — its enterprise value is $8 billion. Company B has $5 billion in debt and $500 million in cash — its enterprise value is $14.5 billion. If both generate $1 billion in EBITDA, Company A trades at 8x EV/EBITDA while Company B trades at 14.5x. The P/E ratio might look similar for both, but the EV/EBITDA reveals that Company B's equity holders are paying far more per dollar of operating profit because they're also absorbing the debt load.

In practice, Apple's enterprise value of $4.08 trillion and its trailing EV/EBITDA of roughly 75x reflects its massive share buyback program — Apple spent $90.7 billion repurchasing stock in fiscal 2025 alone. Coca-Cola's EV/EBITDA of 99x appears expensive, but that metric is distorted by its asset-light franchise model and $46 billion in debt used primarily for acquisitions and shareholder returns. Alphabet, by contrast, carries minimal net debt relative to its $3.8 trillion enterprise value, making its 84x EV/EBITDA a cleaner read of its operating valuation.

EV/EBITDA is particularly valuable for comparing acquisition targets (since acquirers assume the target's debt), evaluating capital-intensive businesses where depreciation significantly reduces reported earnings, and screening across industries with different capital structures. The metric's main limitation is that it ignores capital expenditure requirements — a company spending heavily on growth will have the same EBITDA as one coasting on existing assets.

Free cash flow — operating cash flow minus capital expenditures — represents the cash a company actually generates after maintaining and expanding its business. Unlike earnings, free cash flow cannot be manufactured through accounting decisions. It is the money available for dividends, share buybacks, debt reduction, and acquisitions.

Apple's free cash flow trajectory illustrates why this metric matters. In fiscal 2022, Apple generated $111.4 billion in FCF. That dipped to $99.6 billion in 2023, recovered to $108.8 billion in 2024, and came in at $98.8 billion in fiscal 2025 (which ended September 2025). At a market cap of $3.89 trillion, Apple trades at roughly 39x trailing free cash flow — expensive by historical standards, but backed by one of the most predictable cash generation machines in corporate history.

The price-to-free-cash-flow ratio is especially useful for evaluating companies with heavy depreciation (where earnings understate true profitability), companies with aggressive working capital management, and mature businesses where growth capex is minimal. Amazon's P/FCF of 165x reflects its massive ongoing capital expenditure — $39.6 billion in Q4 2025 alone on an annualized basis — to build out AWS data centers and logistics infrastructure. That spending suppresses current free cash flow but creates future earning power. By contrast, Coca-Cola's P/FCF of 105x looks high, but the company returns virtually all of its free cash flow to shareholders through dividends ($15.4 billion in annual payments) and buybacks.

The key insight is that free cash flow yield — FCF divided by market cap — lets you compare stocks to bond yields. Apple's FCF yield of roughly 1.3% vs. the 10-year Treasury at 4.08% means investors are accepting a much lower current yield in exchange for the expectation that Apple's cash flows will grow over time.

Discounted cash flow analysis is the theoretically correct way to value any asset: project all future cash flows, then discount them back to today using an appropriate rate that reflects the time value of money and the risk of those cash flows. In practice, DCF is both the most powerful and most dangerous valuation tool because small changes in assumptions produce enormous swings in the output.

A simplified DCF for Apple might project $100 billion in annual free cash flow growing at 5% for the next 10 years, then 3% in perpetuity. Using a 9% discount rate (reflecting Apple's equity risk), the present value of those cash flows totals roughly $2.3 trillion — about 40% below Apple's current market cap. To justify the current price, you'd need to assume either faster growth, a lower discount rate, or both. This exercise reveals a fundamental truth: at a 33.5x P/E, the market is pricing in significant future growth that current financials alone don't justify.

The three variables that drive every DCF are the growth rate of future cash flows, the discount rate (which reflects risk and opportunity cost), and the terminal value assumption. The terminal value — what the business is worth at the end of your projection period — typically accounts for 60-80% of a DCF's total value, which means the least certain part of the analysis carries the most weight. This is why Warren Buffett has said he's never actually seen a DCF analysis he found reliable for a business he didn't already understand deeply.

With the 10-year Treasury yielding 4.08% in February 2026, the risk-free rate component of any discount rate has risen substantially from the near-zero rates of 2020-2021. This mechanically reduces DCF valuations — when risk-free rates rise, future cash flows are worth less today. It's one reason many growth stocks have seen multiple compression over the past two years even as their underlying businesses continued to grow.

Dividend yield — annual dividends per share divided by the stock price — is the simplest measure of what a stock actually pays you to own it. Coca-Cola's annual dividend of approximately $2.04 per share on a $79.84 stock gives a yield of about 2.6%. Apple pays roughly $1.04 annually on a $264.58 stock, yielding just 0.4%. Amazon and Alphabet pay no regular dividends at all.

But dividend yield alone is misleading. What matters is total shareholder return: dividends plus share buybacks plus stock price appreciation. Apple's 0.4% dividend yield looks paltry until you add the $90.7 billion in share buybacks from fiscal 2025 — equivalent to roughly 2.3% of its market cap returned through repurchases. Combined, Apple returned approximately 2.7% of its market cap to shareholders in a single year, while simultaneously investing $12.7 billion in capital expenditures to maintain its business.

For income-focused investors, the dividend payout ratio — dividends as a percentage of earnings — signals sustainability. A company paying out 30% of earnings (like Apple) has ample room to maintain and grow its dividend. A company paying out 90%+ of earnings has little buffer if profits dip. Coca-Cola's payout ratio is particularly high because the company uses debt to fund returns beyond its earnings, a strategy sustainable only as long as the company maintains investment-grade credit and steady cash flows.

The total return framework also helps resolve the growth-vs-value debate. A stock with no dividend but 20% annual earnings growth may deliver better total returns than a 5% dividend yield stock with zero growth. The key question is always: what is the company doing with the cash it generates, and how effectively is it compounding capital on your behalf?

No single metric tells the whole story. Professional investors use multiple valuation methods simultaneously, looking for convergence. When P/E, EV/EBITDA, P/FCF, and DCF all suggest a stock is cheap — or expensive — the signal is strongest. When they diverge, the differences reveal something important about the company's capital structure, growth trajectory, or accounting.

Start with the P/E ratio as a quick screen, but immediately check whether earnings are distorted by one-time items, stock-based compensation, or accounting choices. Move to EV/EBITDA to account for debt — particularly important for companies with significant leverage like telecom firms, utilities, or private equity-backed businesses. Use price-to-free-cash-flow to verify that reported earnings are backed by actual cash generation. Run a rough DCF only when you have high confidence in future growth assumptions, and always stress-test the result by varying the discount rate and growth rate.

Compare every metric to the relevant peer group and to the company's own historical range. Apple at 33.5x earnings looks expensive vs. its 10-year average of roughly 20x, but cheaper than its 2021 peak above 40x. Context matters more than absolute numbers. And always consider what the market might be missing — the best investment opportunities arise when the consensus valuation framework overlooks a structural change in the business.

Finally, remember that valuation is necessary but not sufficient. A cheap stock can stay cheap (or get cheaper) if the business is deteriorating. An expensive stock can deliver excellent returns if growth exceeds expectations. Valuation tells you what you're paying — understanding the business tells you what you're getting.