How Earnings Affect Valuation
Earnings affect Valuation of a Company
The more earnings a company generates relative to the number of shares it has outstanding, the more valuable each share is to investors.
Therefore, when evaluating a company, analysts calculate the earnings-per-share, or EPS.
EPS is a metric that divides the earnings available to common shareholders by the number of outstanding shares a company has.
For example, if a company has $100,000 in earnings and 50,000 outstanding shares, then its EPS is $2 per share.
Example of How Earnings Affect Valuation
Analysts also use the price-to-earnings ratio, or P/E ratio, which is the market price of a share divided by the EPS.
For example, if the same company sold each share for $10, then the P/E ratio is 5.0.
Analysts take this number and compare it to other P/E ratios of similar companies, and with the broader market.
In equity valuation, using ratios such as P/E is called a multiples-based approach.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.