Several ratios are calculated not from the income statements and balance sheets of organizations, but from data associated with their stock market performance. The three most common ratios are earnings per share (EPS), the price-earnings ratio (P/E), and the dividend-yield ratio:
EPS = (net income – preferred dividends) /
common shares outstanding
P/E = market price per share / earnings per share
Dividend yield = annual dividends / price per share
EPS is one of the most widely used statistics. Indeed, it is required to be given in the income statements of publicly traded firms. As we can see, the ratio tells us how much the firm has earned per share of stock outstanding. As it turns out, this is not generally a very helpful statistic. It says nothing about how many assets a firm used to generate those earnings, and hence nothing about profitability. Nor does it tell us how much the individual stockholder has paid per share for the rights over that annual earning. Further, accounting practices in the calculation of earnings may distort these ratios. And finally, the treatment of inventories is again problematic.
The P/E is another ratio commonly cited. Indeed, P/Es are reported in daily newspapers. A high P/E tends to indicate that investors believe the future prospects of the firm are better than its current performance. They are in some sense paying more per share than the firm’s current earnings warrant. Again, earnings are treated differently in different accounting practices.
Finally, from the perspective of some stockholders at least, dividend policy may be important. The dividend-yield ratio tells us how much of its earnings the firm pays out in dividends versus reinvestment. Rapidly growing firms in new areas tend to have low dividend-yield ratios; more mature firms tend to have higher ratios.