Measuring Equity Returns: The Five Metrics Every Investor Should Know
I'm Andy Temte and welcome to Money Lessons! Join me every Saturday morning for bite-sized lessons that are designed to improve financial literacy around the world. Today is April 18, 2026.
Last week, we explored dividends and learned that dividends and price appreciation together contribute to your total return as a stock investor. But that raises a question: how do investors evaluate whether a stock is worth owning in the first place? Today, we're walking through the key metrics investors use to measure equity returns—starting with earnings per share, a concept we introduced briefly a few weeks ago.
From Dividends to Earnings: A Shift in How Investors Think
For most of stock market history, dividends were the primary reason people bought stocks. If you were an investor in the 1800s or early 1900s, you judged a stock almost entirely by the income it paid you. A company's value was its dividend—full stop. This made sense in a world where financial information was scarce, accounting standards were inconsistent, and trust between companies and shareholders was still being built.
That began to change in the 1930s and 1940s. The Securities Exchange Act of 1934—which we covered in our November 2025 episode on the rise of market regulation—required public companies to file audited financial statements for the first time. Investors could now see what a company actually earned, not just what it chose to pay out. By 1970, the SEC had formalized standardized quarterly reporting, giving investors a regular window into corporate performance.
This transparency opened the door for a new way of thinking about stocks. Benjamin Graham—who we introduced in our railroad episode as the father of value investing—was among the first to argue that investors should look beyond dividends and examine a company's underlying earnings, assets, and financial health. His 1934 book Security Analysis, co-authored with David Dodd, laid the intellectual foundation for earnings-based valuation. The shift unfolded over decades, but the direction was clear. Investors moved from asking "How much does this stock pay me?" to "How much does this company earn?"
That question leads us directly to our first metric.
Earnings Per Share: The Foundation
Earnings per share—or EPS—is one of the most widely followed numbers in investing. We touched on it two weeks ago when we discussed buybacks, but it deserves a fuller treatment.
EPS tells you how much profit a company generates for each share of stock outstanding. The calculation is straightforward: take the company's net income—its total profit after all expenses and taxes—and divide it by the number of shares outstanding.
If a company earns $50 million in net income and has 25 million shares outstanding, its EPS is $2.00. If the company buys back 5 million shares, the same $50 million in earnings is now spread across 20 million shares—producing an EPS of $2.50. The company didn't earn more money, but each remaining share represents a larger slice of those earnings. That's the buyback dynamic we explored two weeks ago.
Here's why EPS matters: it gives you a standardized way to compare companies of very different sizes. A company earning $10 billion sounds more impressive than one earning $500 million—until you learn the first has 20 billion shares outstanding (EPS of $0.50) while the second has only 100 million (EPS of $5.00). On a per-share basis, the smaller company is far more profitable for its shareholders.
The Price-to-Earnings Ratio: What Are You Paying for Those Earnings?
Once you know a company's EPS, the natural next question is: what price are investors willing to pay for each dollar of earnings? That's exactly what the price-to-earnings ratio—or P/E ratio—tells you.
The P/E ratio is calculated by dividing the stock's current price by its earnings per share. If a stock trades at $40 and the company earns $2.00 per share, the P/E ratio is 20. In simple terms, investors are paying $20 for every $1 of annual earnings—or put another way, at the current rate, it would take 20 years of earnings to equal the price you paid.
A higher P/E generally means investors expect the company's earnings to grow significantly—they're willing to pay a premium today because they believe tomorrow's earnings will be much larger. Technology companies and fast-growing businesses often carry high P/E ratios for this reason. A lower P/E might mean the market expects slower growth, or it could mean the stock is undervalued relative to what it earns. This is exactly the kind of distinction Graham taught his students to investigate.
The historical average P/E ratio for the S&P 500 has hovered around 15 to 20 over the long term—a useful benchmark, though it varies considerably across industries and market conditions.
The Dividend Payout Ratio: How Much Goes Back to Shareholders?
Last week, we talked about how some companies pay dividends while others reinvest everything. The dividend payout ratio puts a number on that choice. It's calculated by dividing the total dividends paid by the company's net income—or equivalently, dividing the dividend per share by EPS.
If a company earns $4.00 per share and pays $1.00 in dividends, its payout ratio is 25 percent—the company is returning a quarter of its earnings to shareholders and retaining the rest. A mature utility might have a payout ratio of 70 or 80 percent, reflecting stable earnings and limited growth opportunities. A young technology company might have a payout ratio of zero—putting every dollar back into building the business.
The payout ratio connects two concepts we've already covered: EPS and dividends. It tells you how a company is balancing the tension we explored through the VOC story last week—the push and pull between returning cash to owners and reinvesting for growth.
Two More Tools for the Toolkit
The P/E ratio works well for companies with consistent, positive earnings—but not every company fits that profile. Young companies may have little or no earnings. Companies in cyclical industries may see their earnings swing wildly from year to year. In those situations, two additional ratios become useful.
The price-to-sales ratio—or P/S ratio—compares a stock's price to its revenue per share rather than its earnings. Revenue is harder to manipulate than earnings and doesn't disappear during a rough year the way profits can. When earnings are negative or highly volatile, the P/S ratio gives investors a way to assess whether the stock's price is reasonable relative to the size of the business.
The price-to-book ratio—or P/B ratio—compares a stock's price to its book value per share. Book value is the company's total assets minus its total liabilities—what shareholders would theoretically receive if the company liquidated everything and paid off all its debts. A P/B ratio below 1.0 means the stock is trading for less than the value of its net assets, which can signal either a bargain or a business in serious trouble. Graham was a strong advocate of this ratio—it was one of his primary tools for identifying undervalued stocks.
We'll revisit both the P/S and P/B ratios in more depth when we explore how investors apply valuation methods and the distinction between growth and value investing later in our series.
What This Means for You
These five metrics—EPS, the P/E ratio, the dividend payout ratio, and the price-to-sales and price-to-book ratios—are the basic vocabulary of stock evaluation. No single number can replace careful thinking, but together they give you a framework for asking the right questions: Is this company profitable? What am I paying for those profits? How is the company balancing returning cash to shareholders versus reinvesting for growth? And when earnings don't tell the full story, what other measures can help?
Next week, we'll explore a security that sits right at the boundary between stocks and bonds—preferred stock. It pays a fixed dividend like a bond but represents ownership like a stock, and understanding where it fits will deepen your grasp of both.
Until next week... Grace. Dignity. Compassion.
