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Several common measures are available for calculating the value of common stock. While most shareholders look mainly for the price per share, it’s not the only indicator of a stock’s worth. Other factors include: earnings per share, the price-earnings ratio, net asset value per share, and yield.

Return on Equity

Return on equity (ROE) is a very important stock measure because it has a direct impact on the company’s growth, profits, and dividends. It shows the overall profitability of the corporation, and seizes how much success the company is having in managing its assets, operations, and capital. The better the ROE, the better the financial condition and position of the firm. Stable or increasing ROEs are good indications. However, stocks with falling ROEs should be avoided.

Earnings Per Share

This is the most commonly referred-to indicator of a stock’s value. Whenever you turn on CNBC or look at the stock pages of the Wall Street Journal, there are mentions of earnings per share (EPS). The traditional way to compute this is to find the income of a corporation that is available to its shareholders. This is net corporate profit after taxes and minus any dividends to preferred shareholders. This figure is then divided by the number of outstanding common shares of stock.

For example, XYZ Corporation reports that its net corporate profits (after taxes) are $5.8 million. They must pay $1 million out in preferred dividends. The remaining $4.8 million is divided by the number of XYZ’s outstanding common shares, which is 1.2 million. Thus, their EPS is $4 per share.

$5.8 m - $1 m = $4.8 m = $3.20/share
1.2 m s + .3 m s = 1.5 m shares

This method of calculating EPS is called the “basic earnings per share.” It is also known as “trailing earnings per share” because it is based upon the corporation’s reported earnings, which are in the past. Quarterly and semiannual EPS also use this method. However, analysts will also forecast a company’s future earnings and base their EPS on these.

Companies also have what are called “diluted earnings per share.” These are computed by dividing the available income to common shareholders by the number of outstanding shares of common stock plus any shares that would be outstanding if any employee stock options or stock awards outstanding, convertible securities and warrants were considered (dilutive potential common shares). In some cases, the difference between the basic EPS and the dilutive EPS is great, solely because of the number of dilutive potential common shares. Note the difference in the earnings per share in our example when dilutive potential common shares are considered. EPS drops from $4/share to $3.20/share.

$5.8 m - $1 m = $4.8 m = $3.20/share
1.2 m s + .3 m s = 1.5 m shares

Analysts usually place a lot of emphasis on earnings per share. It’s important to note that when they discuss EPS, they generally are referring to the diluted earnings per share. They also cite the EPS when discussing the trend for certain companies. However, we can say that the share price will keep up with the earnings per share, either rising or falling. In the past few years, we’ve seen more of a disregard for EPS when it came to new issues and hot dot.com stocks, which was due, in part, to the fact that these companies had no earnings. But with the market downturn, we’ve returned to using the EPS as an indicator of how a company is doing.

Price-Earnings Ratio

The price-earnings ratio (P/E ratio) for a common stock is found by dividing the share price of the stock by the current earnings per share. Therefore, from our previous example, XYZ’s EPS was $4 per share. If their stock price was $55 per share, their P/E ratio would be 13.75 ($55/$4).

The P/E ratio is also a highly respected method of measuring a stock’s value. Generally, the lower the P/E ratio, the better the stock buy. However, a high P/E ratio is all right if the company’s earnings are expected to grow. When evaluating a stock, it’s a good idea to look at the historical P/E ratio data. Looking at the trends for a par- ticular stock will help you decide if the present is a good time to buy or not. If you find that the present P/E ratio is pretty low when compared to the historical figures, the stock may be a good purchase.

Net Asset Value per Share

Net asset value per share, or book value per share, is the amount of assets a company has working for each share of common stock. It’s calculated by taking the net balance sheet values of corporate assets and subtracting the face value of any creditors’ and preferred shareholders’ claims. This number is then divided by the number of outstanding shares. So, for XYZ Corporation, the company’s assets totaled $59 million and their debts and preferred stock claims were $21 million. The remaining $38 million is divided by the number of outstanding shares, 1.2 million. Thus, their book value per share is $31.67.

$59 m - $21 m = 38m/1.2 m shares = $31.67

Generally, the book value for a stock is not a widely used indicator of the stock’s value. It also isn’t as important as the company’s ability to generate an earnings stream. For growth stocks, the market value could be many times the book value. Conversely, for companies that are in either static or declining industries, book value may be much greater than market value.

Yields

For common stocks, yields can be measured as “nominal yields” or “current yields.” These measure the rates of return for a stock. When considering whether to buy, keep, or sell a stock, it’s important to calculate the yields, so you can make an informed decision. Nominal yields are calculated by taking the annual interest or dividends paid and dividing it by the stock’s par value. This is often called the “dividend rate” when applied to preferred stock. Nominal yields really have no meaning for common stocks. Current yields, though, are a more meaningful measurement for investors. This is found by dividing the annual investment income by the security’s current price. Current yields can be applied to common $38 m

and preferred stocks, as well as bonds. Remember, these yields change all the time due to the fluctuation in stock prices. XYZ Corporation declares and pays a $2-per-share dividend. Currently, their stock is selling for $60 per share. Their current yield is 3.3 percent.

$2/$60 = 3.3%

Sometimes current yields and historical data on current yields can be misleading. There are companies who increase their dividends on a regular basis, thus increasing the current yield each time. Then there are companies who, while very stable and financially sound, have made a practice of paying little or no dividends. To calculate properly the overall rate of return on a stock, go back and look at the average annual compound rate of gain (or loss) over a period of time, assuming all dividends and capital gains were reinvested. This considers all capital gains and losses on the stock, instead of just dividends.