How to Calculate Stock Prices Using Price-to-Earnings Ratio

The average P/E ratio is between 12 and 15.

The average P/E ratio is between 12 and 15.

A company's price-to-earnings ratio (P/E ratio) is a commonly used valuation metric that shows the ratio between the company's market price per share and the company's earnings per share (EPS). If you know a company's P/E ratio as well as its net income, amount of preferred dividends paid out and number of shares of common stock outstanding, you can determine the stock's current market price per share.

Determine the company's EPS. To do so, obtain a copy of the company's income statement and identify on the income statement the company's net income, preferred dividends paid out and the number of shares of common stock outstanding. Subtract the amount of preferred dividends paid out from the company's net income. Divide the result by the number of shares of common stock outstanding. For example, if Company X had a net income of $9.1 million, paid out $350,000 in preferred dividends and had 2.7 million shares of common stock outstanding, you would determine Company X's EPS as follows: ($9,100,000 - $350,000)/2,700,000 shares = 3.24.

Find the company's P/E ratio by bringing up a stock's main page on a free financial website such as Yahoo! Finance or MSN Money where the company's P/E ratio should be listed.

Multiply the company's EPS by its P/E ratio. The result is the company market price per share. Continuing with the same example, if Company X has a P/E ratio of 8 and an EPS of 3.24, you would determine Company X's market price per share as follows: 8 x 3.24 = $25.92. This means that shareholders in the company are paying $25.92 for every dollar the company earns.

Items you will need

  • Income statement

Tip

  • Do not base your investment decisions solely on a stock's P/E ratio. Prior to investing in a stock, you should look at additional financial ratios including but not limited to: book value per share, EPS, return on capital employed, return on net worth, debt-to-equity ratio and return-on-cash-flow ratio.

About the Author

Lisa S. Kramer is a licensed attorney practicing civil litigation and estates and trusts law in southern Florida. She received her Bachelor of Arts in English from the University of Florida, where she graduated Phi Beta Kappa and cum laude. Kramer earned her Juris Doctor from the University of Florida Levin College of Law.

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