MARKET ACADEMY
Separate a business improvement from a change in the price paid for it.
Separate a business improvement from a change in the price paid for it.
A company’s equity value depends on the cash flows shareholders may ultimately receive, their timing and risk. Revenue growth matters only through its impact on margins, reinvestment and future cash generation. Profits and cash flow differ because working capital, capital expenditure and non-cash accounting charges matter. A company can beat last year’s earnings and still disappoint investors if its outlook is weaker than the expectations built into the price.
The price-to-earnings ratio divides price per share by earnings per share. Forward and trailing earnings are not interchangeable. A higher multiple may reflect better growth, quality or lower risk; it may also reflect optimism that later proves excessive. Compare companies with similar accounting, capital intensity and earnings durability. Enterprise value includes claims of debt and equity capital providers; EV/EBITDA and P/E use different numerators and denominators and should not be mixed.
An index is a rules-based basket, not a single company. In a capitalization-weighted index, the largest constituents have the greatest influence. A rising headline index can coexist with a majority of stocks declining if a few heavyweights rise strongly. Breadth describes participation across constituents; sector performance helps explain whether moves are broad or concentrated. Compare total-return indices consistently and remember that foreign investment returns also depend on currency.
Simplified share price = expected EPS × forward P/EHypothetical EPS rises from $5 to $5.50 (+10%), but P/E falls from 20× to 17×. Price goes from $100 to $93.50: −6.5%. Stronger earnings did not offset a lower multiple. This identity explains a price change; it does not establish fair value.