Lemonade Stand Example:
Let’s assume Lydia opened a Lemonade Stand (with a permit) on the corner of Bellaire St and Montview that earns $50 a week.
Let’s also assume Lydia started this Lemonade Stand three years ago when she was in 6th grade but now she wants to stop because she’s starting High School.
She’s a clever girl and wants to sell her lemonade stand and the permit since it has a profit of $50 a month.
If she comes to your daughter, how much should you be willing to pay for it ?
At first you offer $200 to Lydia. Surprisingly she said “you’ll earn that back in 4 weeks, I want $7,000 because because $50 a week turns into $2,600 a year (52 weeks a year) and in 3 years your daughter can earn $7,800. So paying $7,000 with a profit of $800 in 3 years for 2 hours of work on Saturday’s.”
As you mull over this significant investment she changes her mind because she got a hold of a youth group at a local church who is willing to pay $9,000 because they will have a steady stream of appropriately aged kids who can run the lemonade stand in perpetuity.
P/E (price to earnings or price to profit)
When were you thinking about paying $7,000 for $7,800 of revenue the P/E is $0.89
The youth group who paid $9,000 has a P/E of 1.15 (9,000/7,800).
The lower the P/E the better because it essentially refers to how much of your investment is chasing each dollar of earnings. So Tesla has a P/E of more than $1,000, so that means you are paying $1,000 for every dollar of earnings.
EPS (Earnings Per Share)
What if the Youth Group decided it’s not appropriate for a church to own a Lemonade stand but the kids want to own it themselves. So 10 of them agree to come up with $900 a person so all of them can pay $9,000.
The Earnings per share becomes 780 ($7,800/10)
Dividend Yield
As an owner it’s important the lemonade stand decide if they will keep the profits with the company so they can re-invest in the business (maybe they want to open another stand in Cheesman Park) or if they want to divvy out the profits or a part of the profits.
The Dividend Yield is a measure of the Dividend you’re getting per year compared to the stock price. It makes it easy to compare stocks with their dividend and price.
So if the Lemonade Stand decides to give out $1,000 in dividend a year the dividend yield is 11.1% ($100/$700)
ATC 