Earnings per share (EPS)
Earnings per share formula
Here preferred dividends are reduced from profit because EPS is only considering income available to common shareholders.
If we use the number of shares for calculating EPS, we cannot compare previous year EPS and current year EPS If the company issues new shares during the year because the number of shares is not a common property for both times. So in order to resolve this issue, we can use a weighted average common shares to normalize the EPS so we can use this property to compare both figures.
What are the earnings per share and, what does it tell you?
The EPS is one of the most widely used and common variables by the investors when selecting better stocks.
The earnings per share ratio are one of the most used matrices among investors for analyzing stocks. EPS shows how much earnings the company generates for each share of its stock.
What does it mean by higher earnings per share?
A higher EPS compared to the industry average indicates that the company is generating higher earnings than most of the other companies in the industry. Investors can assume the company is generating enough profits to cover all the costs and to pay dividends. Investors can confirm the dividend payments by checking the previous dividends history.
What does it mean by lower earnings per share?
A lower EPS compared to the industry or another company means the company is generating lesser earnings than industry or other companies. Due to this, the share price of the company may go down. This may indicate that the stock is undervalued.
Some times law EPS means the company is really in a bad position. To understand the real situation of the company, investors should not trust only on EPS. We need to use multiple other indicators to get a clear idea about the company standings.
What does it mean by negative earnings per share?
A negative EPS on a stock means the company is losing money.
How to use earnings per share?
Usually, investors like to buy shares with higher EPS, but shares might be overvalued.
The EPS growth is a reflection of company growth, so if the EPS is increasing by each year, investors can expect growth of share price due to the predictable future company growth. This is a very good sign of a healthy company, so it is very good indicators for investors to invest money in a company.
Stocks with low EPS might be undervalued. Required careful and thorough investigation about company details if you want to invest in stocks with low EPS.
Risk of using earnings per share and when not to use earnings per share
The earnings per share of the company may be higher due to a lesser number of shares available in the company. The company can manipulate EPS by merge stocks or through buying own stocks. So always evaluate multiple indicators when selecting stocks.
The EPS does not consider the company's debt into account.
Some times law EPS means the company is really in a bad financial position.
EPS doesn’t consider the cost involved to generate earnings. So 2 companies with equal EPS do not indicate both the companies equal in earnings. One company may generate the same earning at lesser cost while the other takes higher costs.
So never take decisions by only looking at EPS. Always analyze as possible by considering different factors like other ratios and business news. Always try to use multiple ratios combinedly to get a more clear picture of a company.