The earnings ratio (also known as the PE ratio) analyses the firm’s current share price against how much money each share is generating. This gives investors an idea about the likely returns (money) they could make if they decided to buy shares in the firm.
How to Calculate Earnings Ratio
To calculate earnings ratio find out the market price per share and the earnings per share AND divide the market price for each share by the earnings made by share.
Earnings Ratio Market Price per Share (pence/cents)
Earnings per Share (pence/cents)
For example if a firm’s market price per share is £10 and the earnings per share is 50p, the earnings ratio would be calculated as follows:
Earnings Ratio 1000
= ______ = 20
What Does the Answer (Earnings Ratio) You Get Mean?
The earnings ratio shows how many times the firm’s current share price is bigger than the earnings each ordinary share generates; or in other words how many times the firm’s current share price is bigger than earnings per share. Another way to describe the earnings ratio is that it shows how much money you need to spend on shares to make one pound/dollar from the shares you buy.
Will a Firm Always Have the Same Earnings Ratio?
The earnings ratio will change as and when the market price for the firm’s shares changes. The number of times that the firm’s share market price changes (throughout the year) will depend on the firm, economic conditions and the industry that the firm is based in.