What a stock is worth: earnings and P/E

Two numbers do most of the work in valuing a company. Earnings per share (EPS) is the company's profit divided by its number of shares: your share's slice of the profit. The price-to-earnings ratio (P/E) is the share price divided by EPS: how many years of today's profit you are paying for.

A P/E of 20 means a buyer pays $20 for each $1 of yearly profit. Investors pay more for companies they expect to grow fast or to be steady, and less for slow, risky or cyclical ones.

The lesson in that widget: price = EPS × P/E, so your return comes from profit growth plus any change in the P/E. When the P/E is already high, it has further to fall.

Comparing companies. P/E only makes sense next to growth and profitability. A bank growing slowly at 12× and a chipmaker growing fast at 35× can both be fairly priced. Here are real numbers from covered companies:

Forward P/E uses analysts' estimate of next year's profit. If it's well below the trailing P/E, profits are expected to grow. For the whole market, the CAPE uses ten years of earnings to smooth out booms and busts; it's on the Markets page.

Other yardsticks. For companies without profits, price to sales compares the price with a year of revenue. For banks, price to book compares it with net assets. Free cash flow, the cash left after running and investing in the business, is harder to dress up than profit. Dividend yield is the yearly dividend as a share of the price.

Analyst targets are 12-month price forecasts from brokerage analysts. They are useful as a summary of opinion but lean optimistic, and they tend to follow the price rather than lead it. Every stock page shows them alongside these ratios.