![]() ![]() Figure 1 shows the data on a normal scale chart, Figure 2 shows the same data on a logarithmic scale, which highlights the relationship between the two more clearly. By adding up the price of every share in the S&P500, and comparing that to the sum of all earnings-per-share generated by those companies, you can easily calculate the P/E ratio of the US stock market.īelow are both the total S&P500 aggregate value, and aggregate earnings. The same analysis can be done to the entire stock market. This is why high-growth companies tend to have very high P/Es - the market has very high expectations for their future results (relative to current results). ![]() TechCo is a new company, and has been growing profits very quickly over the last 5 years, clearly investors expect that to continue. This is twice as high as ACME - but why? If it takes twice as long for TechCo to make profits as it does for ACME, why is their stock valued at the same price? The answer is obviously the growth rate of TechCo's profits. The message here is that, at current earnings, investors in TechCo will theoretically get their money back after 20 years. Because the most recent earnings-per-share for TechCo is $5, that means TechCo's P/E ratio is $100/$5 = 20. Let's also assume that TechCo's current share price is $100, just like ACME in the prior example. Imagine TechCo was founded 5 years ago, and their earnings per year (per share) have been $0, $1, $1.50, $2, and $5. Let's look at another example - one where we expect future earnings to grow. P/E is (unless otherwise stated) calculated using the last reported actual earnings of the company. For example, if you buy 1 share of ACME Co for $100, and ACME consistently makes profits of $10 per-share, per-year, then it follows that it would take the investor 10 years to earn back their original $100 investment. The P/E then becomes a measure of how many years it will take the investor to earn back their principal from the initial investment. The implied logic here is that a mature firm (with no capex investments) returns all profits to shareholders via dividends. The P/E ratio is (as the name suggests), a ratio of a stock price divided by the firm's yearly earnings per share. P/E ratios are a cornerstone of fundamental stock valuation analysis, and are most commonly looked at for individual firms. ![]()
0 Comments
Leave a Reply. |