What Is a Company Worth? — slides
Financial Literacy Club
Understanding Businesses · Lesson 9
What Is a Company Worth?
Market value, earnings multiples, and why price isn't the same as value.
16-minute lesson · learnwithflc.org
What Is a Company Worth? · 1 / 20
Financial Literacy Club
Understanding Businesses · Lesson 9
What Is a Company Worth?
Market value, earnings multiples, and why price isn't the same as value.
16-minute lesson · learnwithflc.org
Today's goals
By the end of class, you'll be able to…
- Calculate market capitalization and the price-to-earnings (P/E) ratio
- Explain what a high P/E suggests about expectations
- Distinguish price from value
Warm-up
A pizza shop earns $50,000 a year in profit. What's the most you'd pay to buy it? Why?
Think, then write your answer.
The big idea
What Is a Company Worth?
Market value, earnings multiples, and why price isn't the same as value.
Understanding Businesses · Lesson 9
A company is worth what it's expected to earn for its owners in the future. That's simple to say and very hard to measure, because the future is uncertain.
Vocabulary
Market capitalization
Share price × number of shares. It's what the stock market says the whole company is worth today.
Vocabulary
Price-to-earnings (P/E) ratio
Share price ÷ earnings per share — or, for the whole company, market cap ÷ net income. It shows how many dollars investors pay for each $1 of yearly profit.
Understanding Businesses · Lesson 9
A high P/E usually means investors expect fast growth. A low P/E can mean slow growth, higher risk — or a bargain. The number alone doesn't tell you which.
Understanding Businesses · Lesson 9
Price is what you pay; value is what you get. Market prices reflect expectations and mood, which can run far ahead of — or far behind — what a business actually earns.
Understanding Businesses · Lesson 9
Expectations cut both ways
When a company with a high P/E grows more slowly than expected, its price can fall sharply even if it's still growing. The expectations were part of the price.
See it
Two hypothetical companies each earn $10 million a year. Company A is valued at $150 million, a P/E of 15, because it's expected to grow slowly. Company B is valued at $500 million, a P/E of 50, because investors expect fast growth.
| Company A | Company B | |
|---|---|---|
| Yearly net income | $10 million | $10 million |
| Market cap | $150 million | $500 million |
| P/E ratio | 15 | 50 |
| What investors expect | Slow, steady growth | Fast growth for years |
Real example
Buying a pizza shop
A hypothetical pizza shop earns $80,000 a year in profit for its owner. The owner is selling it for $400,000.
- That's 5 times yearly earnings — a P/E of 5.
- If profits stay flat, a buyer would earn back the price in about 5 years.
- Questions to ask: Will profits last? Does the shop depend on the current owner's recipes or relationships? How much would it cost to open a competing shop?
Valuing a public company works the same way, just at a bigger scale — and with more guessing about the future.
Activity · pairs · 10 min
Buy the Pizza Shop
- The shop earns $60,000 a year in profit. Seller A asks $300,000. Seller B asks $900,000 for an identical shop in a fast-growing neighborhood.
- Pairs calculate each price as a multiple of earnings and the years of profit needed to earn back the price (ignoring growth).
- Pairs decide whether either price could make sense, and what would have to be true about growth or risk.
Check for understanding · 1 of 3
A company has 10 million shares, and each trades at $25.
What's its market cap?
- A$25 million
- B$2.5 million
- C$250 million
- D$35 million
C. $250 million
10,000,000 × $25 = $250,000,000.
Check for understanding · 2 of 3
A company's market cap is $600 million, and its yearly net income is $20 million.
What's its P/E ratio?
- A30
- B12
- C3
- D620
A. 30
$600 million ÷ $20 million = 30. Investors pay $30 for each $1 of yearly profit.
Check for understanding · 3 of 3
A company with a P/E of 60 reports that profits grew 15% this year. Investors expected 40%.
What's a likely market reaction?
- AThe price rises because profits grew.
- BThe price may fall because growth fell short of high expectations.
- CNothing — P/E ratios don't change.
- DThe company is removed from the stock market.
B. The price may fall because growth fell short of high expectations.
A high P/E bakes in high expectations. Missing them can drop the price even when the business is growing.
Remember
Key takeaways
- Market cap = share price × shares.
- P/E = price ÷ earnings per share (or market cap ÷ net income).
- High P/E = high expectations.
- Price is what you pay; value is what you get.
Discuss
Talk it over
- Would you rather buy a company with a P/E of 10 or 50? What would you want to know first?
- Why might two smart investors disagree about what a company is worth?
Exit ticket
What does a high P/E ratio suggest?
Answer on your exit ticket before you leave.
Nice work today.
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