P/E ratio and dividends, explained

Start with earnings per share

A company’s earnings are its profit after expenses, interest and taxes. Because companies have very different numbers of shares, investors usually divide earnings by the share count to get earnings per share (EPS): the slice of profit that belongs to one share.

You’ll see two versions. Trailing EPS uses the last twelve months of reported results. Forward EPS uses analysts’ estimates for the next twelve months. Trailing numbers are facts but backward-looking; forward numbers look ahead but are only estimates and can be wrong.

The P/E ratio

The price-to-earnings ratio (P/E) divides the share price by EPS. It answers a simple question: how many dollars are investors paying today for each dollar of yearly profit?

Flip the ratio and you get the earnings yield: $4.00 ÷ $60 = 6.7%. Some people find that easier to compare with other things, such as interest on savings, but remember that earnings are not cash paid to you and can change from year to year.

What a high or low P/E can mean

A P/E on its own is just a number. It becomes useful when you compare it with something sensible: the company’s own history, similar companies in the same industry, or the broad market.

• A high P/E (say, a $90 stock earning $3, a P/E of 30) often means investors expect earnings to grow quickly. If that growth doesn’t arrive, the price can fall even while the company stays profitable.
• A low P/E can mean the stock is out of favor and cheap, or that investors expect earnings to shrink. A low number is a reason to look closer, not proof of a bargain.
• No P/E usually means the company lost money over the last year. Division by a negative number doesn’t give a meaningful ratio, so most sites leave it blank.
• Cyclical companies, whose profits swing with the economy, can show a low P/E at the top of a cycle (when earnings are temporarily high) and a high one at the bottom.

Comparisons across industries are tricky. Fast-growing software firms and slow-growing utilities usually trade at very different P/Es, and both can be reasonable.

Dividends: cash paid to shareholders

A dividend is cash a company pays to its shareholders, usually from profits. Many US companies pay quarterly. Others pay monthly, twice a year, once a year, or not at all; younger companies often reinvest everything in the business instead.

Dividends aren’t guaranteed. The board decides each payment and can raise, cut or suspend it. When a dividend is paid, the company’s cash goes down by that amount, so the share price tends to drop by roughly the dividend on the ex-dividend date, all else being equal. A dividend is a way of receiving part of your return in cash, not extra money on top of the stock’s value.

Dividend yield and payout ratio

A moderate payout ratio leaves room to keep paying through a bad year. A payout ratio near or above 100% means the company is paying out everything it earns, or more, which may not last unless earnings recover. Some kinds of companies, such as real estate investment trusts, are structured to pay out most of their income, so check what is normal for the industry.

The dates that decide who gets paid

• Declaration date: the company announces the amount and the dates.
• Ex-dividend date: you must own the shares before this date to receive the payment. If you buy on or after it, the seller gets the dividend.
• Record date: the date the company checks its list of shareholders. With US stock trades settling one business day after the trade, the ex-date and the record date are usually the same day.
• Payment date: the cash arrives in your account, often a few weeks later.

Buying just before the ex-date to “capture” a dividend rarely works the way people hope, because the share price usually falls by about the dividend when the stock goes ex-dividend. Depending on your account and where you live, the dividend may also be taxable.

Common traps

• One-off gains (selling a division, a tax benefit) can inflate earnings for a year and make the P/E look low. Look for “adjusted” or “operating” earnings and read what was excluded.
• Share buybacks reduce the share count, which raises EPS even if total profit is flat.
• Stale numbers: trailing EPS changes only when a new quarter is reported, so a P/E can drift for weeks on price alone.

Used together, P/E, yield and payout ratio give you a quick, rough picture of what you’re paying and what the company shares with you. They are starting points for reading a company’s reports, not a verdict on whether to buy.