5.2: Common Stock Ratios

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Video - Audio - YouTube (Material for this section starts on slide #8.)

The common stock ratios are popular financial ratios that convert key information about a firm to a per share basis. They are also known as market ratios. We introduced a few in our Introduction to Stock in chapter 3. Others are new. These ratios use data from the Balance Sheet or the Income Statement or both.

Earnings per Share (EPS)

Earnings per Share is the amount of annual earnings available to common stockholders, as stated on a per share basis. We can think about each share that we own as a business entity in and of itself, earning X amount of dollars. Earnings per Share was one of the key statistics that we asked you to research in our chapter 3 assignment. It is readily available and a subject of much discussion and speculation, especially with regard to companies that are growing their earnings.

Net Income Earnings Per Share = ———————————————————————————— Number of Shares Outstanding

The Earnings per Share is subsequently used in combination with current market price to compute the most important stock market statistic, the Price-to-Earnings Ratio (P/E).

Price-to-Earnings Ratio (P/E, PE)

The Price-to-Earnings Ratio is the most popular stock market statistic. It is often abbreviated as either P/E or just PE. A simple Internet search will yield tons of materials dedicated to the study, investigation, scrutiny, and dissection of the P/E ratio of a company or the stock market as a whole. The calculation is easy.

Market Price per Share Price-to-Earnings Ratio = ———————————————————————— Earnings per Share

Historically, P/E ratios were in the 5 to 12 range for mature companies and 14 to 20 range for growing companies. Greater than 20 was unusual. Today, it is commonplace. Assuming no changes in earnings, the P/E ratio also tells you how long it will take in years for the company to earn back its price. A P/E of 3 will take three years; a P/E of 20 will take twenty years. In the heady dot-com mania days, eBay once had a P/E of 10,000 associated with the stock. Recently, Tesla’s P/E was over 1,000.

Let’s take a look at the P/E ratios for a random set of companies:

Price-to-Earnings Ratios for a random set of companies
ExxonMobil	8.35	Facebook	20.08
Amgen	19.50	Wells Fargo	14.94
General Mills	16.32	Bristol Myers Squibb	23.42

These companies are all in very different industries. It would not be proper to compare the P/E ratios ‒ or any of the financial ratios that we will cover ‒ of these companies to one another. What we need to do is compare these companies to their competitors:

Price-to-Earnings Ratios for a similar companies in various industries
ExxonMobil Chevron ConocoPhillips Shell BP	8.35 8.84 7.22 5.43 n/a	Facebook Google Apple Netflix Amazon	20.08 20.17 25.38 33.20 n/a
Amgen Biogen AbbVie Illumina	19.50 12.85 23.33 n/a	Wells Fargo U.S. Bank J. P. Morgan Bank of America	14.94 12.95 11.80 10.78
General Mills Kraft Heinz Kellogg’s Hormel	16.32 20.03 23.20 24.12	Bristol Myers Merck Pfizer Eli Lilly	23.42 18.90 7.35 44.43

All data as of March 6, 2023

We must always compare any financial ratios with companies within the same industry. Sometimes the ratios will vary wildly as in the drug companies above. Other times, they will be within a very narrow range such as the energy, food, and banking companies. When we encounter a situation such as the outsized P/E ratio of Eli Lilly or the much lower P/E ratio of Pfizer, it is a signal to us that we must do much more research. Why is this company so different from its peers? Why are P/E ratios of BP, Amazon, and Illumina reported as “n/a?” This signifies that these companies are losing money. Rather than display a negative P/E ratio, the industry typically uses “n/a” for not applicable or “nmf” for no meaningful figure.

How can we account for the wide P/E disparity between different industries and different companies within industries? It is the expectation of future earnings and dividend growth by investors. The following quote is attributed to Jack Dreyfus, the founder of The Dreyfus Funds, which are now owned by The Bank of New York Mellon. (The Bank of New York, incidentally, was the first stock that was traded on the New York Stock Exchange in 1792.)

“Take a nice little company that has been making shoelaces for 40 years and sells at a respectable six times earnings ratio. Change the name from Shoelaces, Inc. to Electronics and Silicon Furth-Burners. In today’s market, the words “electronics” and “silicon” are worth 15 times earnings. However, the real play comes from the word “furth-burners” which no one understands. A word that no one understands entitles you to double your entire score. Therefore, we have six times earnings for the shoelace business and 15 earnings for electronics and silicon, or a total of 21 times earnings. Multiply this by two for furth-burners and we now have a score of 42 times earnings for the new company.” ‒ Jack Dreyfus, Founder, Dreyfus Funds, as quoted in A Random Walk Down Wall Street

Today, you replace furth-burners with cryptocurrency or 3-D printing and replace electronics and silicon with NFT and meme stocks. Technology changes rapidly; human nature, not so much.

Price-to-Earnings to Growth Ratio (PEG)

The Price-to-Earnings to Growth Ratio, also known as the PEG ratio, compares the P/E ratio with the company’s earnings growth rate. The formula is:

Stock's P/E Ratio PEG Ratio = —————————————————————————————————————————— 3-year or 5-year Growth Rate of Earnings

A PEG Ratio of 1.0 means that P/E Ratio matches its growth rate. Historically, a PEG Ratio of 1.0 was desirable since it meant that the P/E Ratio equaled the growth rate. Anything above 1.0 was considered high and therefore, risky. However, greater than 1.0 is common as of this writing. This is another indication that stocks are generally on the expensive side of March 2023, even after many of the high flying “disruptive” companies have fallen from great heights such as Netflix and Shopify.

Dividends per Share

The Dividends per Share tells us how much dividends each share of stock will receive.

Annual Dividends Paid to Shareholders Dividends per Share = ——————————————————————————————————————— Number of Shares Outstanding

As we discussed, dividends became taboo during the 1990’s. Since the 2000-2002 bear market, many investors have changed their minds about dividends. Dividends can be discussed in polite company again. Remember: Dividend Don’t Lie!

Dividend Yield

The Dividend Yield is the important measure of how much dividends are as a percentage of the stock price.

Dividends per Share Dividends Yield = ———————————————————————— Market Price per Share

This important statistic allows an investor to compare a company to other forms of investments that pay income such as savings accounts or bonds. Traditionally, 4% to 6% was considered good. According to the Nasdaq, as of March 2023, the S&P 500 as a whole was yielding 1.68%. After many years of meager returns from savings accounts and bonds, yields have risen for both. As of March 2023, the 10-year Treasury bond was yielding approximately 4%. A year before, the 10-year Treasury bond was yielding approximately 2%. Many savings accounts that were yielding far less than 1% are now paying upwards of 4%. We will see if the yield of stocks rises along with the yields of bonds and savings accounts. Of course, for this to happen, either stocks must pay higher dividends (the numerator increases) or stock prices must fall (the denominator decreases). There are many experts who have exclaimed that stock prices have been too high for too long and that stock prices must come down to more reasonable levels so that the dividend yields will be more in line with historical returns. Since the Great Recession, they have been wrong. We shall see what the future brings. Stay tuned for further developments.

Dividend Payout Ratio

The Dividend Payout Ratio tells us how much of a company’s earnings are being paid out to shareholders in the form of dividends.

Dividends per Share Dividends Payout Ratio = ————————————————————— Earnings per Share

More mature companies often pay out almost all their earnings in the form of dividends. Growing companies retain their earnings (called Retained Earnings) to support the growth of the company.

Book Value per Share

The Book Value per Share is a measure of the net worth of a company on a per share basis. The formula is:

Common Stockholders’ Equity Book Value per Share = —————————————————————————————— Number of Shares Outstanding

Book Value per Share tells an investor how much assets are behind each share of stock. In other words, if all the assets of the company were liquidated, how much would each shareholder receive? It is common for the actual market price of a share to be more than the book value per share since a company is typically worth more intact than if it were dissolved. Today, it is common for the market price to be far above the book value. Remember that the actual Fair Market Value of a corporation’s assets may be very different from what the accountant’s declare the value of the asset to be worth “on the books” because of the various methods of depreciation.

There are rare occasions when the market price of a share of stock falls below the Book Value per Share. Usually, these are very mature companies in declining or disappearing industries. When this happens, there is a real danger of the company becoming a target for corporate raiders. The corporate raiders are also known as private equity groups, activist investors, and takeover artists. Depending upon the company, through various methods, the corporate raiders might attempt to liquidate the assets of the company, pay the remaining debts, and walk away with whatever is left over. They might attempt to sell off various valuable pieces of the company, profiting from the sale but leaving the remaining company unable to compete.

Understandably, the employees of the company and citizens of the community in which the company does business don’t normally take too kindly to this. They complain to their elected representatives and calls to rein in unbridled capitalism are heard. Imagine if you had worked at the same company for 22 years and were now out of job because someone flew in on their private jet, sold off all the assets of the business, and closed its doors forever. This is the reason, Dear Readers, that we have unemployment insurance. A society wants its capital ‒ physical and human ‒ to be employed as efficiently as possible. If a business is failing for whatever reason, that capital needs to be redeployed. However, when you are trying to feed your family and keep a roof over your heads, those high ideals are not your first priority. Hence, we created unemployment insurance to help individuals stay afloat as they find new work, or in other words, as their human capital is redeployed.

Price-to-Book Value per Share

The Price-to-Book Value per Share ratio compares the market price of the stock to the Book Value per Share. This calculation makes it easy for us to see if the market price is above, the same, or below the Book Value per Share.

Market Price per Share Price-to-Book Value per Share = ———————————————————————— Book Value per Share

Given that the Book Value per Share is often less than the market price, the Price-to-Book Value per Share tells an investor how far above the book value the market value is. If the Price-to-Book Value per Share is equal to 1, they are the same. Today, Price-to-Book-Values per Share of 3 to 6 are not uncommon and some are much higher.

Price-to-Cash Flow per Share (P/CF)

The Price-to-Cash Flow per Share ratio is very similar to the Price-to-Earnings Ratio. The exception is that we use Cash Flow per Share instead of Earnings per Share.

Market Price per Share Price-to-Cash Flow per Share = ———————————————————————— Cash Flow per Share

As we discussed above in the section on the Cash Flow Statement, the Earnings per Share can differ dramatically from the Cash Flow per Share for various reasons. During discussions by analysts and market pundits, you may hear talk of the quality of earnings of the company and whether the earnings are “good quality” earnings or “bad quality” earnings. What they are trying to identify is what is happening to the cash flow of the company. Is the company reporting record earnings and at the same time their cash flow is falling? As we saw with Lucent Technologies, this type of situation can end badly for investors.

Price-to-Sales per Share (P/S)

The Price-to-Sales per Share ratio is another attempt to compare the market price with a number associated with the running of the business. In this case, we use the company’s Sales per Share.

Market Price per Share Price-to-Sales per Share = ———————————————————————— Sales per Share

During the Internet mania, many analysts used Price-to-Sales instead of Price-to-Earnings since most of the new high-flying technology companies never generated any earnings.