The Mathematics of Money

Copyright © 2008, The McGraw-Hill Companies, Inc.

Definitions 12.3.10 and 12.3.11

Ratio Formula What It Tells You

Earnings per share (EPS) ________________To tal net income

Number of shares

How much did the business

earn per share of stock?

Book value per share

To tal owners’ equity

_____________Number of shares

How much equity is attributable

to each share of stock?

Example 12.3.5 Thomas Hydrometer Sales Corp is a public company with 3,000,000

total shares outstanding. Calculate the company’s 2007 earnings per share and book

value per share as of December 3, 2007.

Earnings per share  $4,780,851___________

3,000,000

 $1.59 per share

Book value per share  ____________$20,535,025

3,000,000

 $6.85 per share

To compare the price of a company’s stock to its financial position, several per-share

ratios are in common use. Two of the most commonly used per share ratios are:

Definitions 12.3.12 and 12.3.13

Ratio Formula What It Tells You

Price-to-earnings (PE) ratio

Price per share

_______________________Annual earnings per share

[If earnings are positive; the

ratio is undefi ned if earnings

are negative (i.e., the

business lost money)]

How much someone buying

the company stock is paying

for each dollar of annual

earnings. A high PE ratio

indicates that the stock

price is expensive relative to

current earnings.

Price-to-book ratio

Price per share

_______________________Annual earnings per share

How much someone buying

the company’s stock is

paying for each dollar’s

worth of equity. A high

price-to-book ratio indicates

that the stock is expensive

relative to the company’s

owners’ equity.

Example 12.3.6 As of the close of trading last Friday, Thomas Hydrometer Sales’

stock was selling for $37.45 per share. Calculate the PE and price-to-book ratios.

Explain what these ratios tell you about the company.

PE  $37.45_______

$1.59

 23.55

Price to book 

$37.45

_______

$6.85

 5.47

An investor buying stock in this company would be paying $23.55 for each $1 of earn-

ings; or, in other words, the market value of the company is 23.55 times its 2007 earnings.

Similarly, an investor would pay $5.47 for each dollar of equity in the company, or the total

market value of the company is 5.47 times its owners’ equity.

The price-to-earnings and price-to-book ratios do not have to be calculated on a per share

basis. They can also be calculated by using the total market price for the business divided

by the total earnings.

12.3 Financial Ratios 513