Relationship Between Earnings & Stock Market Value
Earnings are the profit a company makes after all the expenses are paid. Stock investors are very interested in the earnings amounts of the companies represented by different stocks. The value of a company's share price is often related to the company's current and projected earnings. One reason to invest in a stock is to participate in the earnings growth of the company.
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Identification
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Publicly traded corporations --- companies with stocks available to investors --- are required to report earnings quarterly or four times a year. Earnings are determined by subtracting the company's expenses from the revenues earned from sales or services provided. The earnings are reported on the company's income statement. Earnings per share are the net earnings for a specific period divided by the number of company shares outstanding.
Price-to-Earnings Ratio
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The price-to-earnings ratio (P/E) is a commonly used stock-market indicator. The P/E is used to evaluate the relative value of a stock. A P/E ratio is calculated by dividing the current stock price by the cumulative earnings per share for the last four quarters. For example, if a stock has a current share price of $20 and the earnings per share for the last year was $2 per share, the stock has a P/E ratio of 10.
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Evaluating With Price-to-Earnings Ratio
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The P/E ratio is used as to compare relative values. A stock with a P/E of 20 is considered to be more expensive than one with a P/E of 15. The stock with the lower P/E may have a higher stock price but has the lower valuation when the company's earnings are taken into consideration. Comparing P/E ratios works best when comparing companies in the same industry or when comparing a company's current ratio to its historic P/E ratio.
Earnings Report Dates
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Corporations are required to make quarterly financial reports. Stock market analysts make predictions on the amount of future per-share earnings for specific companies. On the earnings release date, investors and analysts check to see if a company's earnings were higher or lower than the estimates. When a company reports earnings that are significantly different than the estimates, the stock price can move quickly up or down.
Earnings Growth
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Stock market investors are also interested in the earnings growth rates of specific companies. A company with growing earnings will usually be given a higher relative stock value than a company with level or declining earnings. Growth stocks are companies with earnings that are increasing faster than the overall market. A stock with growing earnings will often have a higher P/E ratio and a stock value that's increasing along with the earnings.
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