Market Value Measures

Our final group of measures is based, in part, on information not necessarily contained in financial statements—the market price per share of the stock. Obviously, these measures can only be calculated directly for publicly traded companies.

We assume that Prufrock has 33 million shares outstanding and the stock sold for $88 per share at the end of the year. If we recall that Prufrock's net income was $363 million, then we can calculate that its earnings per share were:

Net income $363

Shares outstanding 33

Price-Earnings Ratio The first of our market value measures, the price-earnings (PE) ratio (or multiple), is defined as:

Price per share PE ratio - F

Earnings per share

In the vernacular, we would say that Prufrock shares sell for eight times earnings, or we might say that Prufrock shares have or "carry" a PE multiple of 8.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

II. Financial Statements and Long-Term Financial Planning

3. Working with Financial Statements

© The McGraw-Hill Companies, 2002

PART TWO Financial Statements and Long-Term Financial Planning

PE ratios vary substantially across companies, but, in 2001, a typical company in the United States had a PE in the low 20s. This is on the high side by historical standards, but not dramatically so. A low point for PEs was about 5 in 1974. PEs also vary across countries. For example, Japanese PEs have historically been much higher than those of their U.S. counterparts.

Because the PE ratio measures how much investors are willing to pay per dollar of current earnings, higher PEs are often taken to mean the firm has significant prospects for future growth. Of course, if a firm had no or almost no earnings, its PE would probably be quite large; so, as always, care is needed in interpreting this ratio.

Market-to-Book Ratio A second commonly quoted market value measure is the market-to-book ratio:

Market-to-book ratio

Market value per share Book value per share

1.12 times

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