Valuation Ratios

Valuation ratios associate stock price to a performance metric.

Some of the commonly used valuation ratios are cash flow per share, EBITDA per share, dividend per share, price to earnings ratio, price to cash flow ratio, price to sales ratio, and price to book value.

When looking at financial ratios, analysts should: apply their prior experience in evaluating firms and industries; consider the company’s publicly stated objectives; and determine industry norms, as the nuances of economic differences across industries can be reflected in their ratios. 

Earnings Per Share (EPS)

Earnings per share (EPS) is considered to be one of the best measures to summarize the performance of a company. The EPS for a company is reported only for common stock. 

A company can have simple capital structure or complex capital structure.

• A company with a simple capital structure can only have common stock, nonconvertible debt and non-convertible preferred stock. It cannot have any potentially dilutive securities (i.e., stock options, warrants, convertible  bonds, and convertible preferred stock). For companies with simple capital structure, we calculate the Basic EPS.
• A company with a complex capital structure also includes convertible securities, stock options and warrants. For these companies, we calculate both Basic EPS and Diluted EPS. The diluted ESP considers the impact of potentially dilutive securities.

Basic EPS

The basic EPS is calculated as follows:

Diluted EPS

Companies with complex capital structures are required to present both basic and diluted earnings per share.

In computing diluted EPS, the potential impact (i.e., the assumed conversion) of potentially dilutive securities is considered in addition to the weighted average shares.

The calculation of Basic EPS and Diluted EPS is explained in detail under Course: Understanding Income Statement.

Price to Earnings Ratio

The Price to Earnings ratio refers to the price of the stock to profit (or net income). It is also known as multiple. Typically a stocks market capitalization to its total annual earnings will give its PE ratio.