- [Male Instructor] The final widely used ratio
that we're going to talk about here
is the price-earnings ratio.
Now, note, earnings means the same thing as net income.
The price-earnings ratio reflects how valuable
a company's current earnings are.
From the standpoint of an investor,
your concern is whether that profitability
is going to grow or shrink in the future.
This expected future earnings growth
is what is reflected in the price-earnings ratio.
Now the price-earnings ratio is computed
as the market value of the company's shares
divided by the company's net income.
Market value of a company's shares
is sometimes called the market capitalization,
or market cap.
This is the amount you would have to pay
to buy 100% ownership of a company.
Now in mid-2018, if you wanted to buy
all the shares of Walmart,
you would have had to pay 280 billion dollars.
If you had some extra money to spend,
you could buy Apple for one point one trillion dollars.
A side note, Apple's the first publicly traded company
in history to exceed one trillion dollars
in market capitalization.
Now, with net income of 10 billion dollars,
the price-earnings ratio of Walmart is 28.
This reflects the market's expectations
of the future growth and earnings of Walmart.
By comparison, Target has a price-earnings ratio of 16.
Every dollar of earnings of Walmart is more valuable
than every dollar of earnings of Target.
Now why's that?
Remember that this computation is based on past earnings.
And when you buy a company, you're buying its future.
So what investors are saying
is that Walmart's earnings may not be that great right now,
but we expect them to grow substantially in the future.
Typically, most companies have price-earnings ratios
between 10 and 30 and we see that Walmart and Target
are both in that range.
A price-earnings ratio of less than 10
means the market expects your company to grow
very slowly in the future.
But a price-earnings ratio of more than 30
means the market expects your earnings
to grow very rapidly in the future.
In the course of teaching various cases over the years,
the highest price-earnings ratio I've ever seen
is 2220, indicating stratospheric expectations
about future growth.