Question:

EPS Jump x pre-existing P/E multiple

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Example: If on Thursday night (after the markets close with no extended hours taken into consideration) company X's share price is $5 per share.X's P/E multiple is 5 with an EPS of $1 and the next day during their earnings announcement they're company earns $1.20 a share. HERE IS MY QUESTION: Am I looking at this situation correctly by saying:"The multiple is currently stagnant at 5 from the previous trading day when the EPS was $1, so now the stock price will automatically adjust to $6 a share (constant P/E multiple x $1.20 in earnings) or is it pure market factors that cause the share price to go up and consequentially the P/E ratio to decrease due to the increased earnings?

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3 ANSWERS


  1. The market does take unexpected changes into account quickly.  However, your theoretical overnight share price jump presumes the market has no foreknowledge of the increase in earnings.  In reality, the market has already made an estimate of increased earnings in most cases, and so the price has already risen in anticipation of that fact.  

    It is only the more rare case of unanticipated significant earnings surprises that causes this kind of jump...and in fact, the surprise often causes an overreaction.  So, in your example, if the company's new announced earnings were $1.20 when the market as a whole expected $1.00, the share price would quite often jump to above $6.  (Downside, negative surprises have the reverse effect.) This is more a matter of market psychology than strict economic efficiency.

    (All of this is leaving aside the fact that a P/E of 5 does not tend to last for very long, being usually either an artifact of a temporary condition, or a temporary mispricing by the market, or perhaps an extremely cyclic industry.)


  2. If you are looking at an historic p/e then, if the info is updated immediately then the 'new' historic p/e will be 4.17 (unless the share price changes. However you should be looking at the prospective or forward p/e ratio. And yes it is market factors.Don't forget the market and therefore share prices are trying to discount the future (i.e. predict what the situation is going to be in, say, 6 months time)

  3. there is no rule or anything like that that dictates that a stock's P/E must remain stable.   All else equal (which in reality is a condition never met), a stock trading at five times earnings will probably continue to trade at five times earnings, and thus the price would tend to rise if EPS rose.  

    As someone else alluded to, one of the many many factors considered would be if the EPS of $1.20 was more, equal to, or less than what was expected.  A positive earnings surprise would obviously likely lead to an increase in price and therefore the P/E.

    Market Factors are everything.  that's why the call it the Market :p

    other factors include movements in the overall market, changes in prevailing multiples, changes in growth estimates, ...literally anything....

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