KNOWLEDGE CHECK
If the earnings per share of a company is $3.85 and the earnings yield is 2.5%, what is the price per share?
$64.94
$6.49
$154.00
$1.54
The Correct Answer and Explanation is:
To find the price per share, we can use the formula related to Earnings Yield: Earnings Yield=Earnings per Share (EPS)Price per Share×100\text{Earnings Yield} = \frac{\text{Earnings per Share (EPS)}}{\text{Price per Share}} \times 100
We are given:
- Earnings per Share (EPS) = $3.85
- Earnings Yield = 2.5%
Let’s plug the values into the formula and solve for Price per Share: 2.5=(3.85Price per Share)×1002.5 = \left(\frac{3.85}{\text{Price per Share}}\right) \times 100
First, divide both sides by 100: 0.025=3.85Price per Share0.025 = \frac{3.85}{\text{Price per Share}}
Now solve for Price per Share: Price per Share=3.850.025=154\text{Price per Share} = \frac{3.85}{0.025} = 154
✅ Correct Answer: $154.00
🔍 Explanation (300+ words):
This problem involves understanding the relationship between a company’s earnings and its stock price using earnings yield. The earnings yield is a financial metric that shows the percentage return an investor earns from each dollar invested in the stock, based on the company’s earnings. It’s the reciprocal of the price-to-earnings (P/E) ratio.
Here’s what each term means:
- Earnings per Share (EPS): This indicates how much profit a company makes for each share of stock outstanding. In this case, it’s $3.85.
- Earnings Yield: This is calculated by dividing the EPS by the price per share and is usually expressed as a percentage. A 2.5% earnings yield means for every dollar you invest, the company earns $0.025.
To find the price per share, we rearrange the earnings yield formula: Price per Share=EPSEarnings Yield (as a decimal)\text{Price per Share} = \frac{\text{EPS}}{\text{Earnings Yield (as a decimal)}}
Substituting in the values: 3.850.025=154\frac{3.85}{0.025} = 154
This tells us that to achieve an earnings yield of 2.5% from a company earning $3.85 per share, you would have to pay $154 per share.
Understanding this helps investors evaluate whether a stock is over- or undervalued. A lower earnings yield typically means a higher price relative to earnings, suggesting the stock might be expensive, unless strong growth is expected.