Legal Definitions - earnings-price ratio

The earnings-price ratio is a financial metric used to evaluate a company's profitability in relation to its stock price. It is calculated by dividing a company's earnings per share (EPS) by its current market price per share. Essentially, this ratio tells an investor how much profit a company generated for every dollar its stock is worth. Often expressed as a percentage, it is the inverse of the more commonly cited price-to-earnings (P/E) ratio.

A higher earnings-price ratio can indicate that a company is generating substantial earnings relative to its stock price, which might suggest that the stock is undervalued or offers a strong return on investment from an earnings perspective. Investors and analysts use this ratio to compare the relative value of different stocks, assess a company's earnings power over time, or compare it against other investment opportunities.

• Example 1: Comparing Investment Opportunities

  An investor is considering two different companies for their portfolio: "Green Energy Solutions" and "Legacy Manufacturing." Green Energy Solutions has a stock price of $75 and earnings per share of $6, resulting in an earnings-price ratio of 8% ($6/$75). Legacy Manufacturing, on the other hand, has a stock price of $120 and earnings per share of $7.20, giving it an earnings-price ratio of 6% ($7.20/$120).

  This example illustrates how the earnings-price ratio helps the investor compare the earnings power of two different companies relative to their stock prices. Even though Legacy Manufacturing has a higher stock price, Green Energy Solutions has a higher earnings-price ratio, indicating that it generates more earnings for every dollar invested in its stock, which might make it appear more attractive from an earnings yield perspective.

• Example 2: Assessing a Company's Value Over Time

  A financial analyst is reviewing "Global Tech Corp." They note that Global Tech Corp.'s current earnings-price ratio is 9%. Looking at historical data, they see that the company's average earnings-price ratio over the past five years has been 7%, and the industry average is currently 8%.

  This example demonstrates how the earnings-price ratio can be used to gauge a company's current valuation against its own historical performance and industry benchmarks. The fact that Global Tech Corp.'s current ratio of 9% is higher than both its historical average and the industry average suggests that the company is currently generating more earnings relative to its stock price than it typically does or more than its competitors, potentially signaling a strong earnings yield for investors.

• Example 3: Comparing Stocks to Other Asset Classes

  A retirement fund manager is evaluating whether to allocate more capital to equities or fixed-income investments. They observe that the average earnings-price ratio for a basket of stable, dividend-paying stocks is 5.5%, while a comparable government bond is offering a yield of 3.0%.

  This example highlights how the earnings-price ratio can be used as a broad comparison tool against other investment types. The 5.5% earnings-price ratio for the stocks indicates that, on average, these companies are generating 5.5 cents in earnings for every dollar of their stock price. This can be weighed against the 3.0% guaranteed return from the government bond, helping the fund manager assess the relative attractiveness of the earnings potential from stocks versus the lower, but more secure, yield from bonds, considering the associated risks.