Why EPS Formula Is Helpful When Judging Stocks To Invest In
Earnings Per Share refers to a company’s profit that’s allocated to each outstanding share of a particular common stock. It indicates the company’s overall profitability, making it easier for investors to project if they’re performing well, or could be facing some serious challenges.
Earnings Per Share (EPS) addresses two primary issues; the total amount of profit earned by the company as well as the profit accrued to the shareholder. Once you’ve acquainted yourself with this information, you can get down to the business of establishing how much you’re willing to pay for the firm’s stock, based on the P/E ratio.
However, it’s important to note that the EPS value doesn’t speak anything about the attractiveness of the stock.
Calculating Earnings Per Share?
Mathematically the earnings per share value is obtained through the following formula:
EPS = Net Income Allocated to the Common Shareholders/ Total Number of Outstanding Common Shares
If no outstanding stock is available, you can utilize the Net Income value. And if there are preferred shares outstanding, dividends should be paid to preferred stockholders before any of the accrued income reaches the common stock.
It’s important to note that two different firms could produce the same EPS value but one could achieve that with lesser equity. With all other things being equal, it means that this company is better than its counterpart since it’s more efficient at utilizing its capital for generating profits. So, an investor, you shouldn’t only rely on a company’s measure of EPS for making investment decisions. Rather, you should use it in conjunction with other measures as well as financial statement analysis. For more information, read Timothy Syke’s EPS Formula Article.
Is A Greater EPS Value Better?
EPS tells so much about how much the firm is making in terms of profits generated by each outstanding share of stock. With a higher EPS, the value of your stock share is likely to be higher since the investors are willing to invest more money for higher profits.
The Importance
An Important Measure Of Profitability
Earnings per share (EPS) is an important metric for measuring a company’s profitability. When it comes to fundamental analysis, EPS is the only metric that’s able to isolate net income and establish what the stakeholders are gaining by making investments in the company. A consistently rising EPS means that investors are getting a good share of the firm’s profits consistently. Increasing earnings per share also indicate that the firm is creating more value for its investors. On the other hand, a consistently falling EPS indicates financial trouble, consistent losses, eroding investor value, as well as low profitability.
EPS generally addresses two primary questions; the amount of profit that a company makes per each outstanding share and the total amount of profit accrued to the shareholder.
Indicates A Company’s Dividend Payout
Dividends represent a firm’s profits that are distributed to the shareholders. Most investors enjoy a steady income involved with dividends. Plus, investors also consider dividends as a positive sign and strong indicator of grown in the company’s future. The firm can only give out dividends if it has excess EPS. Even if dividend payout isn’t directly related to EPS, it’s commonly perceived that only those business institutions that have stable or consistently growing earnings per share, pay dividends to its stakeholders. If you’re an investor who’s looking for dividend income, it’s important that you check the company’s EPS value before investing.
Determines the P/E RATIO
Other than profitability, investors are interested in understanding the value that a certain share brings to their portfolio. The P/E ratio can significantly help investors in valuing their shareholding. And the key determinant of the P/E ratio is EPS.
Mathematically, the P/E ratio is calculated as the Price per Equity Share divided by EPS (Earnings per Share).
Suppose company A possesses one equity share worth $100 and its EPS for the year 2018 is $20.Its P/E ratio will be calculated as 100/20= 5. At current profitability, therefore, the company will take up to 5 years to achieve its market price per equity share. What this means is that investors will remain invested in the firm for 5 years to fully recover their investment. If company B has a market price per equity share of $ 1000 and an EPS value of 100, its P/E ratio will be calculated as 1000/100- 10. And this means the investors will need to remain invested in the company for up to 10 years before they can recover their investment.
If EPS was the only factor to be considered, company B would look better than company A. But looking at the firms’ P/E ratios, company A appears much better, providing a quicker return on investment. Thus, it’s always important to check out a company’s P/E ratio as well as its EPS value so as to make logical investment decisions.
Key Takeaway
EPS is a common financial ratio. It’s easily accessible to investors since most companies provide EPS figures on their annual reports. Plus, it’s often the first ratio that most investors look at before making any investments since it’s easy to understand and provides a clear indication of the company’s profitability. Regardless of its simplicity Earnings Per Share as a metric is remarkably powerful and concentrates important information in a single number. Even more, makes it possible for investors to compare various investment options across different sectors as well as industries. With the EPS formula, investors can also chart the financial performance of certain companies over time, hence making an informed decision.
The Bottom Line
Although it’s important to perform a comprehensive fundamental as well as market analysis procedure before investing in a company, the EPS formula as a metric is also reliable about indicating a company’s value and profitability. It provides investors with a head start to isolate profitable firms from the non-profitable ones. So, if you want to invest like a pro, consider leveraging the power of the EPS formula.
