Determining stock value from price and earnings by Paul T. Holliday
The value of stocks and stock indices are generally derived from such fundamentals as earnings and return on investment. The value that investors place on a stock or stock index may also be found by examining historical data. Value is a function of fundamental parameters such as earnings and interest rates, but fluctuations around the nominal value occur because investors' expectations of future earnings may be optimistic or pessimistic, thus driving the stock price above or below that nominal value.
Just because a relationship is established between price, earnings and interest rates, however, no cause and effect has been proved. A relationship between stock prices and skirt hemlines could be established that might show considerable correlation, but no one could seriously consider this as a causal relationship. However, the relationship between price, earnings and interest rates does coincide with general expectations of how stock prices move.