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“This video. We re gonna talk about the earnings per share ratio and the price price to earnings ratio. So let s begin our discussion with the earnings per share. Also known as the eps you can calculate it by taking the earnings or the net income of a company and dividing it by the shares outstanding assuming.
If the company has no preferred dividends to payout if it does then in this case. You can calculate the earnings per share by taking the difference between the net income and the preferred dividends and then divide in that result by the number of outstanding shares. So those are the ways in which you can calculate the eps for company. So now let s go over an example.
Let s say we have two companies company. A and company b. Now. Let s say that company a has a hundred million dollars in earnings and let s say that company b.
Also has a hundred million dollars in earnings and let s say that neither of these companies are issuing any preferred. Dividends. Let s say they have no preferred dividends to payout now let s say that company a has ten million shares outstanding and company b has 50 million shares outstanding here s a question for you which company has the higher eps value. Which one is the better deal to buy so the eps value for company.
A is going to be the earnings divided by the number of shares. So one hundred million divided by ten million. That s a hundred divided by ten. The eps value will be ten dollars per share now for company b.
We need to divide a hundred by fifty a hundred divided by 50 is two so it s going to be two dollars per share. So if everything else is equal between these two companies. It looks like company a is a better deal because the earnings per share is higher. Now.
It s important to know that as the earnings of a company increases. The earnings per share will increase as well because they re making more money these two are directly related. Now as the number of shares outstanding increases. The eps value the earnings per share will decrease.
These two quantities are inversely related. So as we saw in a case of company b. It had more shares 50 million compared to the 10 million shares of company. A so.
Even though. The earnings was the same. Because company b. Had a greater number of shares outstanding.
Its earnings per share is a lot lower because you have to divide that hundred million in earnings 250 million shareholders if each person had one share now let s talk about what the eps values. Mean a company with a high aps value is the company that is doing pretty good they re making money a company with a low gpa. They re not doing very good they re pretty much doing bad..
So. Let s say. If you have two companies. One has an eps value of let s say positive 560.
Let s call this company. A and company b. Has an earnings per share of let s say negative 380 company b. Is not doing well because the earnings per share is negative that means that they re losing money they re not making money.
But for company a because the earn is for sure. It s positive that tells you that they have earnings to report since the last quarter. They re doing good a positive eps value tells you that the company isn t making money a negative eps value tells you that the company is losing money that means that their expenses is greater than their cells or revenue. If the eps is negative.
Now let s talk about the price to earnings ratio also known as the p e ratio now there s two ways in which you can calculate the p e ratio. Here s the first way you can take the market value of the whole company. Which is basically the market capitalization and then you could divide it by the earnings of the company so that s one way in which you can get the p e ratio. The market capitalization is equal to the number of shares outstanding time is the price of the stock the total earnings of the company can be calculated by taking the shares outstanding and multiplying it by the earnings per share.
So if you cancel the number of shares outstanding you get a second way of calculating the p e ratio. And that is the price of the stock divided by the earnings per share or the eps value so those are the two ways in which you can calculate the p e ratio. So let s use an example let s say we have company a and company b. Let s say that the share price of.
Company a is let s say 4000 and company b. The share price is gonna be the same 40. Now. We re gonna say that the eps for company.
A is 10 per share. And the earnings per share for company b. Let s say it s 5 per share. So which company has the higher p e ratio.
Would you say it s company a or company b so to get the p e ratio of a company a it s going to be the stock price divided by the eps value so 40 divided by 10 is 4 so that s going to be the p e ratio. For company a now to get the price to earnings ratio for company b. Take. The stock price of 40 divided by the earnings per share of 5.
That will give you 8. So what do these numbers tell us. Let s say if these two companies are in the same industry. And let s say everything else is about equal a low p.
E. Value indicates that the company might be undervalued. A high p e..
Value might indicate that the company is overvalued relative to company a now for most companies in a stock market the average p e ratio could be anywhere between 20 and 25 so relative to a typical company both of these companies will be considered undervalued. But company b will be considered overvalued relative to company a if these two are in the same industry so keep that in mind a low p e ratio indicates that the company is undervalued but a high p e ratio is an indication that the company might be overvalued now sometimes you may have a stock with a high p e ratio. And the stock s price could still be climbing higher and in that case. Investors believe that there s a lot more growth potential in his company.
So they re willing to pay a higher price for that stock sometimes a low p e ratio. May not be a good thing sometimes the stock price might get lower and lower. So you have to be careful just because a stock has a low p e. Value doesn t mean.
It s always the best thing to buy the price of the stock can continue in a downtrend. It can keep getting lower and lower so you have to look at other factors as well. But something you do want to know is that as the price of a stock increases the p e ratio will increase as well as the earnings per share increases the p e ratio will decrease those two are inversely related so the p e ratio just tells you if a company might be undervalued or overvalued it tells you the current state of the company and not where it s going not the direction. You have look at other things for that so now we re going to do is we re going to work on some practice problems that help you to understand how these things are calculated like the eps and the p e ratio.
Now has a problem that you could try number one a company has 450 million dollars in earnings and 300 million shares outstanding. The current price of the stock is 30 part a what is the eps. A value of this company so feel free to pause. The video and try this problem.
If you want to let s begin by writing down. The formula. So the earnings per share is going to be the earnings of the company divided by the number of shares outstanding. So the company has 450 million dollars in earnings and 300 million shares outstanding so canceling the unit millions it s going to be 450 divided by 300 and so.
The eps is gonna be a dollar fifty per share now let s move on to part b calculate the p e ratio. The formula that we should use to calculate the price to earnings ratio is the stock price divided by the eps. So the price of the stock is 30. The earnings per share is a dollar 50 so dividing those two gives us 20.
So that s the p e ratio for in this company now let s move on to the next problem number 2 company xyz has four point two billion dollars in net income and 300 million that it must pay i put is let s take that out that should be it that it must pay out and prefer dividends. The company has 900 million shares outstanding and is trading at a stock price of 45 calculate the earnings per share value. So let s begin. The eps value is going to be now we have the preferred dividends in this problem.
So we re going to use this formula. It s going to be the net income minus the preferred dividends divided by the number of shares outstanding now we need to make sure that the unit matches. Because here. The unit is in millions here.
It s in billions. So it s important to understand that one billion dollars is equal to a thousand times a. Million so it s a thousand. M so 42.
Billion dollars to convert that to millions of dollars. You would multiply that by a thousand. So this would be four thousand two hundred million dollars so the net income..
I m gonna replace that with 4200 m. That s 4200 million and the preferred dividends is three hundred million. And the number of shares outstanding is 900 million in order to get the answer right you want to make sure that the unit s match. So 40 200.
300 that s going to be. 3900 so we need to divide 3900 by 900 and this will give us our eps value. Which is going to be 4 dollars and 33 cents. It s four point three repeating.
But we re gonna round it to the nearest cent. So that s the answer for part a that s the earnings per share value. Now. Let s move on to part b.
How much is the price to earnings ratio for this company so let s calculate the p e ratio. So keep in mind we have two formulas we can take the market cap and divided by the earnings or we can take the price and the eps now we know the price of the stock and we know the eps value. So. This is going to be the best way to get the answer so the stock price is 45.
The earnings per share is four dollars and 33 cents and so the p e ratio is going to be ten point three nine and so that s it for this problem number three company abc has a market capitalization of 28. Billion dollars and has four hundred million dollars in earnings and there s no preferred dividends in this problem. The stock is currently trading at 35 part a what is the p e ratio. For this company now we have two ways we can take the stock price which we know and divide it by the earnest per share.
Which we we don t know that value we need to find it in part b. So we need to use the other formula that is when you take the market value of the company. The market capitalization and divided by the total earnings of the company so once again let s convert this into the appropriate unit. If one billion dollars as we said before correspond to a thousand million.
Dollars then 28. Billion dollars just multiply by a thousand. This would correspond to two thousand eight hundred million dollars. So the market cap is twenty eight hundred million.
The earnings is four hundred million. So we could cancel the m. We could cancel two zeros and so this becomes twenty eight divided by four and so the p e ratio is a nice hole number seven so now that we have the p e ratio. Let s move on to part b let s calculate and the eps value so the equation that we ve been using before to calculate the eps value is this one we took the earnings of the company and divided by the shares outstanding.
But as of now we don t know the number of shares outstanding for this company. So we can t use this formula the only other formula that we have that has the p e ratio. I mean the eps the value is this one the p e ratio is equal to the stock price divided by the eps we know the stock price we know the p e ratio. So if we could rearrange that formula then we can calculate the eps and here is the rearranged formula.
The earnings per share is going to be the price per share divided by the price per earnings ratio. So the price per share is 35 the price per earnings. It s basically seven dollars per earnings..
So the weiden needs to we re going to get the earnings per share 35. Divided by 7 is five. So the eps is five dollars per share. Now for those of you who may feel dubious about this you can confirm it using this equation.
So the stock price as we said before is 35 per share. The eps is 5 35 divided by 5 is 7 which gives us the p e ratio. So that s how we know the answer is 5 so now you know how to calculate the earnings per share. If you re given the stock price and the price to earnings ratio.
Now let s move on to part c. Estimate. The number of shares outstanding for this company. The only formula that has the number of shares is this one.
But we need to rearrange. It the number of shares outstanding. There s actually two ways in which we can calculate this the number shares outstanding is going to be the earnings of the company divided by the eps. So i rearranged this equation by swishing these two things which is what i did here i ve switched a p e ratio.
With the eps so you get this form so the earnings is 400 million and the eps. Is 5 now it s not. 5000000. So this unit will not be cancelled.
It s going to be carried over so if we divide 400 by 5. We re gonna get 80. But it s not gonna be 80 shares if we carry over the m. It s gonna be 80 million shares.
So that s one way in which we can calculate the shares outstanding in this problem. The other way is by using the market cap earlier in this video. We said that the market capitalization is equal to the shares outstanding times the price of the stock so to calculate the shares outstanding. We can take you need to divide both sides by the price by the way for those of you who want to see how to get the rearranged formula.
The shares outstanding is going to be the market cap divided by the share price or the stock price so the market cap is. 28. Billion which is. 2800 million and the price of each stock is.
35 so 2800. Divided by 35 will give you 80. As well carry over the m you get the same answer 80 million shares outstanding. So as you can see there s a lot of different formulas that you could use to calculate what you need to calculate so that s it for this video.
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