What gives a share price its value?

On a technical side, it might be easy to imagine that as a shareholder you really own part of a company. If you own 1 share of 100,000 total shares, and the company's current worth is $900,000, each share should technically have the value of $9.00. However, when you buy shares of stock, you are investing in that company's future. You don't really expect a company to sell all their assets in the near future, do you? A better, and more standard, way to value a company's future is based on their reported earnings - the money the company is making from its assets. Earnings are computed as revenues minus operating costs. Another word for earnings is income or profit. A company's earnings are reported quarterly (every 3 months) to the public. For example, Lucy's Lemonade Incorporated might report the following earnings for the previous four quarters.

Lucy's Lemonade Incorporated: Earnings

Now, if you owned some of the 200,000 shares available, your earnings per share (EPS) would be:

Imagine that Greg's Grape Drink Incorporated reported the same total quarterly earnings but had twice as many shares (400,000 compared to 200,000) as Lucy's Lemonade. Compute the EPS for Greg's Grape Drink Inc. for each of the four quarters in the blanks provided below:

As you can see, both businesses have the same total earnings. However, a share of Lucy's Lemonade stock is more valuable than a share of Greg's Grape Inc. The EPS offers a way to level the playing field so that investors can compare the investor profit for companies that offer different amounts of shares to the public (such as Lucy's Lemonade and Greg's Grape Drink). It also allows comparisons between bigger and smaller companies (such as Coke and Lucy's Lemonade).

The EPS allows for some basic comparisons between companies. However, we still don't know what a good price for Lucy's Lemonaide or Greg's Grape might be. Is $10.00 a share too expensive for a share? Is it a great deal? What about $20.00? Just like any product, people who buy and sell shares of stock should know if a certain price is "cheap" or "expensive". The next section will describe the price to earnings ratio and teach us all how to spot low priced and expensive stocks.