Earnings Method or Earning Basis Valuation

By using the earning valuation method, a company will employ its P/E ratio to value its shares.

P/E    =  MV/E

MV    =   E x P/E -> value of ordinary share.

The MV can be determined whereas the estimated earnings have been established with applying the P/E ratio expected of this kind of company.

Example

Company XYZ is expected to make post tax earnings of Sh.200,000 per annum and companies in the similar trade will usually have a P/E ratio of eight.  Upon account of company XYZ limited size, a ratio of six (6) is considered more suitable. The questioned share capital is 1,000,000ordinary shares of Sh.50 each.

Required

Value of shares   = EPS x P/E

                   =       Earnings per share x P/E

                   =       (200,000/1,000,000) x 6

                   =        Sh.12.00

Value of Business = Earnings x P/E ratio

MV  = E x P/E = Sh.200,000 x 6

      = Sh.1.2 million