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Last Updated on June 26, 2022 by coffeepo
Investing in stocks can be a great way to grow your money over time, but it’s important to understand the math behind stock prices before you get started. Here are nine simple equations you need to know. Each of them will help you make smarter investment decisions and increase your chances of earning a return on your money.
1. The Price-to-Earnings (P/E) Ratio
The price-to-earnings ratio is the most commonly used valuation metric in investing. It tells you how much you’re paying for each dollar of a company’s earnings. To calculate the P/E ratio, simply divide a company’s stock price by its earnings per share (EPS).
For example, if a company’s stock price is $30 and its EPS is $3, then its P/E ratio would be 10. That means you’re paying $10 for each dollar of the company’s earnings.
2. The Price-to-Sales (P/S) Ratio
The price-to-sales ratio is another important valuation metric. It tells you how much you’re paying for each dollar of a company’s sales. To calculate the P/S ratio, divide a company’s stock price by its revenue per share (RPS).
For example, if a company’s stock price is $30 and its RPS is $3, then its P/S ratio would be 10. That means you’re paying $10 for each dollar of the company’s sales.
3. The Price-to-Book (P/B) Ratio
The price-to-book ratio is yet another important valuation metric. It tells you how much you’re paying for each dollar of a company’s book value. To calculate the P/B ratio, divide a company’s stock price by its book value per share (BVPS).
For example, if a company’s stock price is $30 and its BVPS is $3, then its P/B ratio would be 10. That means you’re paying $10 for each dollar of the company’s book value.
4. The Dividend Yield
The dividend yield is a metric that tells you how much income you can expect to receive from a stock,relative to the price you paid for it. To calculate the dividend yield, divide a company’s annual dividend per share by its stock price.
For example, if a company’s stock price is $30 and it pays an annual dividend of $1 per share, then its dividend yield would be 3.33%. That means you’d receive $0.033 in dividends for each dollar you invested in the stock.
5. The Earnings Yield
The earnings yield is the inverse of the P/E ratio. It tells you how much income you can expect to receive from a stock,relative to its price. To calculate the earnings yield, divide a company’s EPS by its stock price.
For example, if a company’s stock price is $30 and its EPS is $3, then its earnings yield would be 10%. That means you’d receive $0.10 in earnings for each dollar you invested in the stock.
6. The Return on Equity (ROE)
The return on equity is a measure of how well a company is using shareholder capital to generate profits. It tells you how much income you can expect to receive from a stock,relative to the equity you have invested in the company. To calculate the ROE, divide a company’s net income by its shareholder equity.
For example, if a company has a net income of $30 and shareholder equity of $100, then its ROE would be 30%. That means you’d receive $0.30 in income for each dollar you invested in the company.
7. The Price-to-Earnings Growth (PEG) Ratio
The price-to-earnings growth ratio is a measure of how expensive a stock is relative to its earnings growth rate. To calculate the PEG ratio, divide a company’s P/E ratio by its earnings growth rate.
For example, if a company has a P/E ratio of 10 and an earnings growth rate of 20%, then its PEG ratio would be 0.50. That means the stock is trading at a discount to its earnings growth rate.
8. The Enterprise Value-to-EBITDA (EV/EBITDA) Ratio
The enterprise value-to-EBITDA ratio is a measure of how expensive a company is relative to its earnings before interest, taxes, depreciation, and amortization (EBITDA). To calculate the EV/EBITDA ratio, divide a company’s enterprise value by its EBITDA.
For example, if a company has an enterprise value of $100 and EBITDA of $10, then its EV/EBITDA ratio would be 10. That means you’re paying $10 for each dollar of the company’s EBITDA.
9. The Debt-to-Equity (D/E) Ratio
The debt-to-equity ratio is a measure of a company’s financial leverage. It tells you how much debt the company has relative to its equity. To calculate the D/E ratio, divide a company’s total debt by its shareholder equity.
For example, if a company has total debt of $100 and shareholder equity of $200, then its D/E ratio would be 0.50. That means the company has more debt than equity.
10. The Free Cash Flow (FCF) Yield
The free cash flow yield is a measure of how much cash flow you can expect to receive from a stock,relative to its price. To calculate the FCF yield, divide a company’s free cash flow per share by its stock price.
For example, if a company’s stock price is $30 and it has free cash flow per share of $1, then its FCF yield would be 3.33%. That means you’d receive $0.033 in cash flow for each dollar you invested in the stock.
Conclusion
These are just a few of the most important ratios that you should be familiar with when analyzing a stock. By understanding these ratios, you’ll be able to make more informed investment decisions and improve your chances of success in the stock market.
