Earnings Per Share (EPS)
Portion of a company’s profit allocated to each outstanding share of common stock. For instance, a corporation that earned $10 million last year and has 10 million shares outstanding would report earnings of $1 per share. The figure is calculated after paying taxes and after paying preferred shareholders and bondholders. The EPS is important for calculating the Price Earnings Ratio of a company’s stock.
Price Earnings Ratio (P/E)
(P/E) price of a stock divided by its earnings per share. The P/E ratio may either use the reported earnings from the latest year (called a trailing P/E) or employ an analyst’s forecast of next year’s earnings (called a forward P/E). The trailing P/E is listed along with a stock’s price and trading activity in the daily newspapers. For instance, a stock selling for $20 per share that earned $1 last year has a trailing P/E of 20. If the same stock has projected earnings of $2 next year, it will have a forward P/E of 10.
The price/earnings ratio, also known as the multiple, gives investors an idea of how much they are paying for a company’s earning power.
A company’s stock is deemed to be “overvalued” when its earnings multiple anticipates unreasonably high future earnings. “Undervalued” stock sell at multiples that anticipate unreasonably low future earnings. Query, who determines reasonableness?
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