Earnings per share

Earnings per share is the quotient from dividing the company's income with its average shares outstanding, since the number of tradable shares changes overtime. Stocks are priced based on the company's current earnings or its potential to grow that profit. So looking at the EPS tells you whether a company's stock might be undervalued compared to another company. For example, if two companies have relative market value and shares outstanding, and their stocks are trading at $10. Company A has an EPS of 2 and company B has an EPS of 0.50, It might be possible that company A is undervalued.



Price to earnings ratio

Price to earnings ratio tells you how much investors are willing to pay for a stock in accord with its earnings. To get the ratio, you divide the share price (35.46) with its Earnings per share (3.30). Average P/E out in the market as of this writing is 17-20. Investors look at this number to weigh whether the stock is overvalued or undervalued compared to the income it generates, a lower P/E means the stock is undervalued and a higher P/E indicates a stock price is overdone and is way too expensive compared to its earnings. That is not the case at all times as investors have different views about this metric. Another is that if a company doesn't have the potential to increase its earnings within a set time horizon or its having difficulties financially, its stock would register a lower price to earnings ratio. Since, P/E measures the willingness of investors to pay for a stock in exchange for its profits, a lower ratio should also mean that the current sentiment for a stock is negative or in everyday English, Investors are not confident and they are in doubt regarding a company's ability to generate and grow profits. It might also be that a company's ability to expand profits are overlooked therefore this should fall in the undervalued category.

A higher P/E in this case tells us that investors are willing to bid up the price in exchange for its potential earnings, a newbie company could register stellar P/E of over 100 if investors see that the potential for that company to grow is tremendous. In this kind of situation, speculators create a price bubble meaning the price is way too much to pay for the company's current earnings and the time horizon that their assumed profits and size would be realized. Its all but a tug-of-war between the bulls and the bears, if more investors see that the price is way to early to be set at the present time, they could push it down at a lower level that conforms to their own analysis. Short sellers do look upon these stocks and try to profit from it on the way down. Not all high P/E ratio stocks fall in value, if quarterly earnings increase at a reasonable pace, then the ratio decreases due to higher earnings per share should the price remain little changed since its already been priced long before the quarterly report.

Previous | Next

Stocks | Forex | Options | Economics | Bonds | History | Language learning | Technology | Technical Analysis | Fundamental Analysis
Copyright © 2014 econtrader | Risk disclosure | Terms of Use