Updated: Dec 29, 2020
The current price of a stock is decided by the market, it is the price at which sellers and buyers are ready to trade. But what is the underlying value?
A stock gives you ownership of a slice of a company, every share has an amount of income or loss that is allocated per share which is called Earnings Per Share, management who is voted in by the stockholders, will usually decide how much of that profit should stay in the company and how much should be distributed as a Dividend.
The basic value of a stock is the present value of all the future dividends, however many investors will look more at the Earnings Per Share which relates to future potential dividends than current dividends.
The price of a share divided by its earnings is called the P/E Ratio, the S&P has historically traded at around 15 times earnings and is trading now at around 30 times earnings.
The current high P/E ratio in the market may reflect optimism about future income, very low yields on other assets like bonds, speculation or some combination of these factors.