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