Gain deeper insights into stock investing by understanding market value ratios such as Earnings Per Share and Price-Earnings Ratio, and find out how they can influence investment decisions.
Market value ratios are used to evaluate the share price of a company’s stock.
- Earnings per share (EPS) measures the amount of net income earned for each share outstanding
Earnings Per Share = Net Earnings / Total Shares Outstanding
EPS is one of the many indicators you could use to pick stocks. If you have an interest in stock trading or investing, your next step is to choose a broker that works for your investment style.
Comparing EPS in absolute terms may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings. Instead, investors will compare EPS with the share price of the company.
- Price-Earnings Ratio (P/E ratio) compares a company’s share price to its earnings per share
Price-Earnings Ratio = Share Price / Earnings Per Share
The price-to-earnings ratio or P/E is one of the most widely used stock analysis tools by which investors and analysts determine stock valuation. In addition to showing whether a company's stock price is overvalued or undervalued, the P/E can reveal how a stock's valuation compares to its industry group or a benchmark like the S&P 500 Index.
In essence, the price-to-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive $1 of that company’s earnings. This is why the P/E is sometimes referred to as the price multiple because it shows how much investors are willing to pay per dollar of earnings. If a company was currently trading at a P/E multiple of 20x, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.
The P/E ratio helps investors determine the market value of a stock as compared to the company's earnings. In short, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E could mean that a stock's price is high relative to earnings and possibly overvalued. Conversely, a low P/E might indicate that the current stock price is low relative to earnings.
Market value ratios are very critical and useful for all sorts of stock investing. And be it secondary market investments, be it an investment in a company as a minor or major stakeholder, or be it for merger and acquisition decision, etc. The different market value ratios provide different insights into the company. And investors can decide about their investments and strategies using these ratios.