Earnings per share (EPS) is the most important measure used when analyzing stocks. You can calculate a company’s EPS using the following formula: (Net Income – Preferred Dividends) ÷ Average Outstanding Shares. EPS reflects the theoretical value of the stock that the company deserves, which is something that cannot be known just from revenue figures.
How to Calculate Earnings per Share
The EPS for a company is calculated using the following formula:
For example, suppose you have two companies, Company A and Company B. Both had total revenues of $500 million last year. If Company A had a net income of $100 million, while Company B had a net income of $50 million, your initial reaction might be that Company A is the better option of the two. This is where EPS comes into play.
Let’s assume that Company A has 50 million shares outstanding, while Company B only has 10 million shares. Using the EPS formula, and assuming neither company pays dividends, the results would be as follows:
Company A
($100,000,000 – $0) ÷ 50 million shares = $2.00 per share
Company B
($50,000,000 – $0) ÷ 10 million shares = $5.00 per share
Based on EPS, the earnings per share for Company B is much better. For this reason, it makes sense to look at EPS as a tool for comparing companies because it shows the theoretical value of the stock that the company deserves. This is not something that can be known just from revenue figures.
Calculating EPS is just the starting point in a comprehensive fundamental analysis strategy. However, it is one of the most important parts because other fundamental metrics are derived from it. In fact, there are three different types of EPS figures:
1. Trailing EPS: Uses figures from the previous year and is considered the actual EPS.
2. Current EPS: Uses figures from the current year but is considered a forecast.
3. Forward EPS: An estimate of EPS figures for the upcoming years based on current trends.
As you become more skilled in fundamental analysis, you can begin to track a company’s EPS to see if it is increasing or decreasing. You will even be able to notice the rate of its increase or decrease.
Other Earnings-Related Metrics
In addition, there are other earnings-related metrics, including:
1. Price to Earnings Ratio (P/E): The stock price to earnings ratio.
2. Projected Earnings Growth (PEG): The P/E ratio to the earnings growth rate.
3. Price to Sales (P/S): The company’s market capitalization divided by total sales for the year.
4. Price to Book (P/B): The company’s stock price divided by the book value per share.
5. Dividend Payout Ratio: The amount paid to shareholders as dividends relative to the company’s net income.
6. Book Value: The company’s value after deducting all liabilities from all assets as stated in financial statements.
7. Return on Equity (ROE): The business profitability compared to shareholders’ equity.
In summary, EPS is one of the most important metrics in fundamental stock analysis. It helps you understand the theoretical value of the stock and compare companies. As you develop in fundamental analysis, you can track EPS for companies and monitor its increase or decrease and its rate.
Source: https://www.thebalancemoney.com/fundamental-analysis-understanding-earnings-per-share-3141099
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