The market value of a stock is the amount investors will pay. The current market value, or price, varies from day to day. However, you can use the profit-to-earnings ratio, or P/E ratio, to calculate the average market value over a given period and then compare it to the current market value. You will need some additional information to calculate market value using the P/E ratio.
The P/E ratio is a widely used metric defined as the average price of a share of stock divided by the earnings per share for a given reporting period, usually the previous year. For example, if the price per share averaged $25 and the company earned $2 per share, the P/E ratio is 12.5. The P/E ratio is useful because it helps investors decide if a stock is overpriced or undervalued. For example, a high P/E ratio might indicate a stock is overvalued unless there is good reason to think future earnings growth will justify the high price.
Before you can calculate market value per share with the P/E ratio you need two pieces of information: the company’s net earnings and the number of outstanding shares. Net earnings are stated on a company’s yearly and quarterly income statement, cash flow statement and statement of shareholders’ equity. The number of outstanding shares is stated in a company’s annual report and usually appears on the statement of shareholders’ equity.
To calculate the market value per share, first divide the company’s net earnings by the number of outstanding shares. This gives you the dollar value of the earnings per share. Next, multiply earnings per share by the P/E ratio to find the average market value of a share for the preceding year. Suppose a company had net earnings of $15 million and there are 5 million shares outstanding. That gives you $3 earnings per share. If the P/E ratio is 12.5, the average market value of the share for the previous year was $37.50.
Knowing the average value of a company’s shares for the previous year can be useful. Assume a P/E ratio of 12.5 and average market value of $37.50. After researching the company, you decide that’s about right. Then you look at the current price per share and see it is $50 per share. If $37.50 is a reasonable price, you probably don’t want to pay $50. On the other hand, if the current price has fallen to $25, you may have found yourself a bargain.
- Stockbyte/Stockbyte/Getty Images