A:

Simply put: yes. A company's stock price will factor in many different variables including the type of industry the firm operates in, but profits (or earnings) are a very strong proxy of a company's stock price. In the short run, a company's stock price can make small to large price adjustments, depending on news releases and earnings reports. In the long run, a firm's stock price will depend largely on the firm's overall earnings. So, earnings will be one of the strongest drivers for a company's stock.

The price-earnings ratio (P/E) is one metric used to evaluate how earnings are factored into a company's stock price. This ratio will differ from industry to industry, and firm to firm, because there are different earnings growth opportunities between individual industries and companies. The growth potential in an older industry versus a new industry may be quite substantial. For example, the potential for earnings growth in a rail company will differ from the earnings growth potential for a bio-tech company.

Over the short term, there can be many substantial price shifts in a particular stock, but the vast majority of these price shifts are due to the changes in potential future earnings. The same can be said about the long-term valuations of a stock: earnings will be the main driver of the stock's price. After all, investors will not invest in a company that is not making, nor will ever make, money. This is one of the reasons the tech-bubble burst: tech companies were trading at very large multiples - well into the hundreds - but they were not making any money.

Investors will also factor in more fundamental factors into a stock's price, such as management characteristics and the economics of the industry. All of these factors influence the earning potential of the firm. Good management will produce earnings and industry growth, which will boost firm-specific sales. In short, if you want to maximize your stock price, maximize your earnings in the long run.

To learn more about different ratios used in company evaluations, read our tutorials on the P/E Ratio or Ratio Analysis .

RELATED FAQS
  1. Stocks with high P/E ratios can be overpriced. Is a stock with a lower P/E always ...

    The short answer? No. The long answer? It depends.The price-to-earnings ratio (P/E ratio) is calculated as a stock's current ... Read Answer >>
  2. What are common growth rates that should be analyzed when considering the future ...

    Learn about some of the most commonly used measures for evaluating a company's future growth prospects and analyzing it as ... Read Answer >>
  3. What does the forward p/e indicate about a company?

    Explore the forward price to earnings ratio and learn its significance and how it compares to the traditional price to earnings ... Read Answer >>
  4. How exactly do I use the price to sales ratio to evaluate a stock?

    Learn the best way for investors and market analysts to make use of the price to sales ratio in evaluating a company's stock. Read Answer >>
  5. If I have a number of stock shares and that company reports earnings of X amount ...

    Simply? Yes and no.Part of the answer to your question is "no" because when a company reports $X of earnings per share in ... Read Answer >>
Related Articles
  1. Investing

    Everything Investors Need To Know About Earnings

    We go over the concepts behind the excitement over the most important figure in the stock market.
  2. Investing

    How To Use The P/E Ratio And PEG To Tell A Stock's Future

    While the price-to-earnings ratio is commonly used for assessing stock prices, the price/earnings-to-growth ratio offers forecasting advantages that investors need to know.
  3. Managing Wealth

    How to Use Earnings Season to Make Better Decisions

    Earnings season reflects the state of the stock market, but also demonstrates how the overall economy is performing.
  4. Investing

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  5. Investing

    The 4 Basic Elements of Stock Value

    Investors use these four measures to determine a stock's worth. Find out how to use them.
  6. Investing

    SXC Health Solutions Corp. (USA) Among the Nasdaq's Biggest Movers

    The market is having a bad day so far: the Nasdaq is trading down 0.3%; the S&P 500 has declined 0.4%; and the Dow has slipped 0.5%. The Nasdaq Composite Index is a capitalization-weighted index, ...
  7. Investing

    The Most Important Metrics For Earnings Season

    Knowing how to read an earnings report can help investors decide which stocks to buy.
  8. Insights

    Earnings Forecasts: A Primer

    Learn how this key metric is calculated and how it is used to judge market performance.
  9. Investing

    Beware False Signals From The P/E Ratio

    The P/E ratio is a simple tool for evaluating a company, but no one ratio can tell the whole story.
RELATED TERMS
  1. Earnings

    The amount of profit that a company produces during a specific ...
  2. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  3. Accounting Earnings

    The amount of money a company has earned during a given period, ...
  4. P/E 30 Ratio

    The price-to-earnings (P/E) ratio is the valuation ratio of a ...
  5. Overvalued

    A stock with a current price that is not justified by its earnings ...
  6. Earnings Yield

    The earnings per share for the most recent 12-month period divided ...
Hot Definitions
  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  2. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  3. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  4. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  5. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  6. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
Trading Center