← Money Lessons with Andrew Temte, PhD, CFA
Money Lessons with Andrew Temte, PhD, CFA
Measuring Equity Returns: The Five Metrics Every Investor Should Know
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Foreign. Hi, I'm Andy Tempte, and welcome to Money Lessons. Join me every Saturday morning for bite sized lessons that are designed to improve financial literacy around the world. Today is April 18, 2026. Last week we explored dividends and learned that dividends and price appreciation together contribute to your total return as a stock investor. But that raises a How do investors evaluate whether a stock is worth owning in the first place? Today, we're walking through the key metrics that investors use to measure equity returns, starting with earnings per share, a concept that we introduced briefly a couple of weeks ago. For most of stock market history, dividends were the primary reason that people bought stocks. If you were an investor in the 1800s or early 1900s, you mainly judged a stock by the income that it paid you. A company's value was its dividend. Full stop. This made sense in a world where financial information was scarce, accounting standards were inconsistent, and trust between companies and shareholders was still being developed. That began to change in the 1930s and the 1940s. The securities Exchange act of 1934, which we covered back in November of 2025 in our treatment of the rise of market regulation, well, that required public companies to file audited financial statements for the first time. Investors could now see what a company actually earned, not just what it chose to pay out. By 1970, the SEC had formalized standard quarterly reporting, giving invest a regular window into corporate performance. This transparency opened the door for a new way of thinking about stocks. Benjamin Graham, who we introduced in our railroad episode as the father of value investing, was among the first to argue that investors should look beyond dividends and examine a company's underlying earnings, assets, and financial health. His 1934 book called Security Analysis, which was co authored with David Dodd, laid the intellectual foundation for earnings based valuation. The shift unfolded over decades, but the direction was clear. Investors moved from asking, how much does this stock pay me? To how much does this company earn? And that question leads directly to First Metric. Earnings per share, or eps, is one of the most widely followed numbers in investing. We touched on it two weeks ago when we discussed stock buybacks. But it deserves a deeper treatment. EPS tells you how much profit a company generates for each share of stock outstanding. The calculation is straightforward. Take the company's net income, which is its its total profit after all expenses in taxes, and divide it by the number of shares outstanding. If a company earns $50 million in net income and has 25 million shares outstanding, its EPS is $2. If the company buys back 5 million shares, that same 50 million in earnings is now spread across 20 million shares, producing an EPS of $2.50. The company didn't earn more money, but each remaining share represents a larger slice of those earnings. That's the buyback dynamic that we explored two weeks ago. Here's why EPS matters. It gives you a standardized way to compare companies of different sizes. A company earning $10 billion sounds way more impressive than one earning half a billion. Until you learn that the first company has 20 billion shares outstanding, translating to an EPS of $0.50, while the second company only has 100 million shares outstanding and generates an earnings per share of a whopping $5 on a per share basis, the smaller company is far more profitable for its shareholders. Now let's talk about the price to earnings ratio. Once you know a company's eps, the natural next question is what price are investors willing to pay for each dollar of earnings? That's exactly what the P E ratio, or the price to earnings ratio, tells you. The P E ratio is calculated by dividing the stock's current price by its earnings per share. If a Stock trades at $40 right now and the company earns $2 a share, the P E ratio is 20. In simple terms, investors are paying $20 for every dollar of annual earnings. Or put another way, at the current rate, it would take 20 years of earnings to equal the today. A higher PE generally means that investors expect the company's earnings to grow significantly. They're willing to pay a premium today because they believe tomorrow's earnings will be much larger. Technology companies and fast growing businesses often carry high PE ratios exactly for this reason. A lower P E ratio might mean the market expects slower growth. Or it could mean the stock is undervalued relative to what it earns. This is exactly the kind of distinction that Graham taught his students to investigate. The historical average P E ratio for The S&P 500 has hovered around 15 to 20 over the long term, which is a useful benchmark, though it varies considerably across industries and market conditions. Now let's talk about the dividend payout ratio. Last week we talked about how some companies pay dividends while others reinvest everything. The dividend payout ratio puts a number on that choice. The dividend payout ratio is calculated by dividing the total dividends paid by the company's net income, or equivalently dividing the dividend per share by the earnings per share. So if a company earns $4 per share and it pays $1 per share in dividends, its payout ratio is 0.25 or 25%. So this company is returning a quarter of its earnings to shareholders and retaining the rest. For a mature utility company might have a payout ratio of 70 or 80%, reflecting stable earnings and limited growth opportunities. A young technology company might have a payout ratio of zero, putting every dollar back to work. Building the business the payout ratio connects two concepts we've already covered EPS and dividends. It it tells you how a company is balancing the tension that we explored through the Dutch East India company story last week, the push and pull between returning cash to owners and reinvesting for growth. Now there are two more tools for the toolkit. The P E ratio works well for companies with consistent positive earnings. But not every company fits that profile. Young companies may have little or no earnings. Companies in cyclical industries may see their earnings swing wildly from year to year. In those situations, two additional ratios become useful. First is the price to sales ratio, or P S. This compares a stock's price to its revenue per share rather than its earnings. Revenue is harder to manipulate than earnings and doesn't disappear during a rough year the way that profits can when earnings are negative or highly volatile. The price to sales ratio gives investors a way to assess whether the stock's price is reasonable relative to the size of the business. The next measure is the price to book ratio. This compares a stock's price to its book value per share. Book value is the company's total assets minus its total liabilities. It's an accounting measure. It is what shareholders would theoretically receive if the company liquidated everything today and paid off all of its debts. A price to book ratio below one means that the stock is trading for less than the value of its net assets, which can signal either a bargain or a business in serious trouble. Graham was a strong advocate of the price to book ratio. It was one of his primary tools for identifying undervalued stocks. We're going to talk about value investing versus Growth investing in future episodes. Now, what does this mean for you? These five metrics eps, the P E ratio, the dividend payout ratio, price to sales, and price to book are the basic vocabulary of stock evaluation. No single number can replace careful thinking, but together they give you a framework for asking the right questions. Is this company profitable? What am I paying for those profits? How is the company balancing returning cash to shareholders versus reinvesting investing for growth? And when earnings don't tell the full story, what other measures can I use? Next week we'll explore a security that sits right at the boundary between stocks and bonds. Preferred stock it pays a dividend, a fixed dividend, like a bond, but represents ownership, like a stock. And understanding where it fits will deepen your grasp of both ends of the spectrum. Until next week, I wish you grace, dignity, and compassion. My name is Andy Tempte. This is Money Lessons. You can find the show on all the major streaming services as well as out on YouTube. Please, like, subscribe, rate, and most importantly, share this public good with your friends, your family, your colleagues, and maybe a neighbor. The show was produced by Nick Tempte, and we'll see you next Saturday on Money Lessons.