EPS, P/E and forward P/E
Once you can read an earnings report, the next step is turning it into a price. EPS and P/E are the most quoted numbers in equity markets, and also some of the most misused.
Earnings per share
EPS = net income ÷ shares outstanding
- Basic vs diluted: diluted EPS counts shares that could be created from options, convertible bonds and share awards. It is the more honest number.
- Reported vs adjusted: as in the last lesson, check what has been stripped out.
- Buybacks: reducing the share count raises EPS even if profit doesn’t grow. Ask whether EPS growth is coming from the business or from financial engineering.
The core multiples
| Metric | Formula | What it tells you |
|---|---|---|
| P/E | Share price ÷ EPS | How many years of current profit you are paying for |
| Forward P/E | Share price ÷ next 12 months EPS estimate | The same, using what analysts expect next |
| Earnings yield | EPS ÷ share price (1 ÷ P/E) | Comparable with bond yields |
| EV/EBITDA | Enterprise value ÷ EBITDA | Valuation that accounts for debt |
| Dividend yield | Annual dividend ÷ share price | Cash returned each year as a percentage |
Price is not value
A £5 share isn’t “cheaper” than a £500 one. If two companies each earn £1 per share and one trades at £10 and the other at £30, the first is on a P/E of 10 and the second on 30. You are paying three times as much for each pound of profit.
Trailing vs forward P/E
Trailing P/E uses the last twelve months of actual earnings. Forward P/E uses analyst estimates for the next twelve months. Markets price the future, so forward P/E is what most professionals quote, but it is only as good as the estimates, and estimates tend to be too optimistic at the top of a cycle.
Why multiples differ
A high P/E isn’t automatically expensive. Investors pay more for faster growth, more predictable earnings, stronger balance sheets and lower risk. A low P/E can signal value, or a business in decline (a value trap). The PEG ratio (P/E divided by the growth rate) is a rough way to adjust for growth.
Where P/E breaks down
- Losses: no earnings, no meaningful P/E. Use EV/sales or EV/gross profit instead.
- Cyclicals: miners and car makers look cheapest at peak earnings, just before profits fall.
- Debt: P/E ignores it. EV/EBITDA includes it, which is why it’s used to compare companies financed differently. That is where the next lesson picks up.
Key takeaway
Multiples are a starting point for a question (“why is this one cheaper?”), not the answer.
Educational content only, not financial advice. Investing involves risk and you can lose money.