Effect of a stock split on PE ratio

CFA Level I Corporate Finance
#1

In event of a stock split, I understand both price and earnings will decrease by the same amount.

Therefore, there will be no effect on the PE ratio.

However, I can’t seem to understand how a company’s earnings will be affected by a stock split. Why shouldn’t the earnings remain the same?

Appreciate anyone’s input on this. Thanks!

#2

P/E = price per share / earnings per share

You have # shares in the numerator and denominator so it cancels out.

Another way of looking at the P/E ratio is to multiply the numerator and denominator by # shares, then

P/E = market cap / net income

shares outstnading will not have an effect on either, so the P/E is constant.

#3

but how will the denominator - earnings be affected by a stock split?

#4

It won’t.

The P/E ratio is the total market cap divided by total earnings for the period. Both are unchanged by stock splits or reverse splits. The number of shares outstanding is irrelevant here.

#5

Ok, because I read that the PE ratio will not change because both the P and E will both decrease.

Unlike what you mentioned - no change to both.

thanks for the clarification guys!

#6

P and E will both change.

But that is Price Per Share and Earnings Per Share.

Since they are both on a per share basis, the effect of a stock split is cancelled out when evaluating the P/E ratio.

#7

smiley got it. Thanks dwheats!