The earnings ratio, which is also known as the price/earnings ratio, and the dividend are two factors that investors consider when analyzing stocks. Both provide clues to the strength and value of a stock as investors weigh whether to buy, sell or hold shares. Investors consider either or both measurements depending on personal strategies and preferences in investing in stocks.
Earnings Ratio Basics
The earnings ratio measures the relationship of a stock’s share price to its earnings per share. Share price is the price at which a single share of the stock can be purchased, while earnings per share is a company’s profit divided by the number of outstanding shares. The earnings ratio is calculated by dividing share price by earnings per share.
A dividend is a payment made to investors from a share of an organization’s profits. The payment can be made in cash or another asset, such as shares of stock. In stock investing, dividend payments typically are distributed to investors at regular quarterly intervals. Some stocks decline to issue dividends, instead choosing to reinvest their earnings into the company. Others distribute a portion in dividends and reserve the rest to reinvest. Stock dividends are paid on a per-share basis.
Earnings Ratio and Investing
Investors seeking a value tend to pursue stocks with low earnings ratios, according to the Financial Times. A low ratio demonstrates that the company is producing high earnings in relation to its cost, representing a potential bargain. However, it could mean investors see signs of a dim future for the stock. A high ratio shows that investors are willing to pay a premium on the current earnings. This means that the stock is expensive relative to its current performance. However, investors are willing to pay this high price when they believe that the stock has large potential to grow and produce strong future earnings.
Dividends and Investing
Stocks with dividends attract investors for multiple reasons. A chief one is that dividends allow investors to receive steady income from their stocks. This is especially beneficial for conservative investors who want to hold onto stocks for the long term. Dividends give them some immediate benefit from their investments. Dividends also suggest stability for a company, demonstrating that they have enough consistently strong earnings to reward their shareholders, according to "Making the Most of Your Money," by Jane Bryan Quinn. The tradeoff is that dividends represent money that is not being invested back into the company, potentially curbing growth.