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What is an earnings capitalization ratio?

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Quick Answer

The earnings capitalization ratio of a share is the value of the share in the most favorable conditions possible. It can be determined by dividing the expected yearly earnings of the share by its current price.

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In business, there is a similar concept called the capitalization of earnings rate. It estimates the earning potential of a company, rather than just a share of a company.

To determine the earnings capitalization of a business, the business' expected annual income is divided by the capitalization rate. The capitalization rate is written as a percentage, and expresses the rate of income an investment is expected to realize. For example, if a business was purchased for $1 million dollars and makes $100,000 in a year, the capitalization rate would be 10 percent, because 1 million divided by 100,000 equals .10. The $100,000 of income should be net income, meaning that it is the money generated after expenses, such as costs for payroll and utilities, are subtracted from the gross income.

This concept is often applied to assets of businesses as well. It can be used to determine whether certain investments for a business, such as real estate for additional buildings, are prudent investments.

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