What is the P/E ratio?  P/E ratio = Price per share / Earnings per share  Where E stands for EPS in $, and P stands for the share price in $  EPS: Earnings per share in $  P = Price per share of a stock in $  Implications:  A high P/E ratio often means that the market has high expectations, based on management, growth expectations, as well as knowledge of the company's projects

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What is the P/E ratio? 

P/E ratio = Price per share / Earnings per share 

Where E stands for EPS in $, and P stands for the share price in $ 

EPS: Earnings per share in $ 

P = Price per share of a stock in $ 

Implications: 

A high P/E ratio often means that the market has high expectations, based on management, growth expectations, as well as knowledge of the company's projects. 

Two companies may have the same EPS but very different P/E ratios based on market expectations. Often, we look at a Corp.'s P/E ratio and compare it to the Industry P/E ratio. We can also compare the P/E ratio across industry rivals. 

Using the ratio: If we know the P/E ratio, and Earnings per share, we can find P or the price per share. This is because P= (P/E) x E 

Example: If the P/E ratio is 10 and EPS = $1.5, price per share, P = $15. 

Market Value: Knowing P in turn helps us estimate the market value of the firm. If we have P and the number of shares of common stock outstanding, then the market capitalization or market value of the firm = P * Number of common stock shares outstanding. 

Example: a) If the price of a share is $20 and there are 2 million shares, then 

Market Cap = $20 * 2 million = $40 million 

b) If the share price goes down to $10, then the Market Cap = $20 million 

Problem: 

a) If Corp XYZ reports an EPS of $3.50 and has a P/E ratio of 20, then the price per share = ___________. 

b) If the company has 500,000 shares of common stock outstanding, then the market value of the firm = ______________ 

How do we find EPS? 

EPS = Net Income after taxes or NOPLAT 

# of common stock shares outstanding 

Net Income after taxes in turn found by the following process. 

Revenue - Cost of goods (COGS) sold = Gross Profit or gross margin 

Gross Margin - Operating expenses = Net Income before taxes 

Net Income before taxes - taxes = Net Income after taxes or NOPLAT 

Example: 

Revenues = $ 2 million 

COGS = $1.1 million 

Gross Margin = ____________ 

Operating expenses = $300,000 

Net Income before taxes = __________ 

Adjusted taxes = $160,000 

NOPLAT = _____________ 

If Owner's equity + Retained earnings = $ 1 million and Liabilities = $300,000 

Then Invested Capital or IC = ____________ 

ROIC = ____________