1.4.1.5.5. Measures of Profitability
Earnings per share (EPS):
Earnings per share measures how much of a company’s earnings belong to each share of stock. EPS indicates a company’s profitability. It is also used as the denominator in the price/earnings ratio.
Price to earnings (P/E) ratio:
The P/E ratio measures the price investors are willing to pay for a stock per dollar of earnings. It is used by analysts to determine whether a stock is over- or undervalued. Stocks with higher P/E ratios indicate that investors expect higher future profits and are willing to pay a high price for these expectations. Stocks with high P/E ratios tend to be riskier investments. Stocks with lower P/E ratios are often called value stocks, whereas stocks with high P/E ratios are called growth stocks.
The P/E ratio can also be calculated by taking the market capitalization of a company and dividing it by the company’s net income. The market capitalization is equal to the stock price per share times the number of outstanding shares.
The P/E ratio calculation may be based on either actual historical data or projected future earnings. Whe