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. 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 >>
  2. 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 >>
  3. Why would my stock's value decline despite good news being released?

    More often than not, when a firm releases an earnings report the market will react to this news by adjusting the firm's stock ... Read Answer >>
  4. What is the average price-to-earnings ratio in the banking sector?

    Explore the price/earnings ratio in regard to the banking industry and learn what the average P/E ratio is for most banking ... Read Answer >>
  5. 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 >>
Related Articles
  1. Investing

    Comparing the P/E, EPS And Earnings Yield

    Here are three ratios that help investors value stock returns.
  2. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  3. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  4. Investing

    Understanding The P/E Ratio

    Learn what the price/earnings ratio really means and how you should use it to value companies.
  5. Investing

    5 Must-Have Metrics for Value Investors

    These quick-and-dirty ratios will help you find the most undervalued stocks on the market.
  6. Investing

    How To Find P/E And PEG Ratios

    If these numbers have you in the dark, these easy calculations should help light the way.
  7. Investing

    What are Earnings?

    The amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year.
  8. 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.
RELATED TERMS
  1. Forward Price To Earnings - Forward P/E

    A measure of the price-to-earnings ratio (P/E) using forecasted ...
  2. Long Run

    A period of time in which all factors of production and costs ...
  3. P/E 30 Ratio

    The price-to-earnings (P/E) ratio is the valuation ratio of a ...
  4. Price/Earnings To Growth - PEG Ratio

    Price/Earnings to Growth (PEG) is a stock's price to earnings ...
  5. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  6. Trailing Price-To-Earnings - Trailing P/E

    The sum of a company's price-to-earnings, calculated by taking ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  3. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
  4. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  5. Backward Integration

    A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it ...
  6. Pari-passu

    A Latin phrase meaning "equal footing" that describes situations where two or more assets, securities, creditors or obligations ...
Trading Center