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Calculate Price and Dividend Ratios

Calculate price and dividend ratios to help you figure out the current value of a stock.

Of all the ratios used in stock valuation, probably none is as popular as the price/earnings ratio (sometimes known as the P/E ratio or multiple). The P/E ratio compares the current price of a stock to the amount of money the company has earned. One interpretation of the P/E ratio is the measure of how much investors are willing to pay for each dollar of earnings the company generates. Not only does it help you judge whether a stock’s price is reasonable, it can indicate the confidence investors have in a company’s future. The more investors are willing to pay for a dollar of earnings, the higher their expectations for future performance. If investors won’t pay much for a dollar of earnings, they have little confidence in the company. The P/E ratio is calculated with the formula in Example 4-8.

Example 4-8. Formula for a basic P/E ratio

P/E Ratio = $ Current Share Price / $ Current Annual EPS

You can use a P/E ratio in your stock analysis in a couple of ways. First, you can compare the P/E ratios of two or more similar stocks to determine which stock is a better value. You can also use the P/E ratio as a proxy for a stock’s value. You can’t directly compare the prices of stocks. Is a $32 share of Intel stock really more expensive than a $27 share of Microsoft? However, if you compare the P/E ratios of both companies, you can see whether you’d have to pay ...