What's With The EPS?

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What's With The EPS?

I saw a few definitions for EPS. None of them satisfied me.

They all explained the math, and that was fine. But I don't see how that correlates to how well a company is doing.
So here's an example:

Company A makes $1000 profit and has 500 outstanding shares. Therefore, the EPS is $2

Company B makes $1000 profit and has 1000 outstanding shares. Therefore, the EPS is $1

Given that both companies had equal profit and assuming all other things being equal, then to me, neither company is better than the other. However, based on the definition of EPS, company B is better because it has a higher EPS.
And it has a higher EPS simply because it has less outstanding shares? What does the number of outstanding shares have to do with how good or profitable a company is?

Then I found a definition that made more sense to me. It said:

" Basic Earnings per share (Basic EPS) tells an investor how much of the company's profit belongs to each share of stock. If company ABC reported earnings of $100 million dollars and had 20 million shares outstanding, the basic EPS would be $5 ($100 million earnings ÷ 20 million shares outstanding = $5 per share). The figure is important because it allows analysts to value the stock based on the price to earnings ratio (or p/e ratio for short)."

It is the last sentence that made sense to me; i.e. "The figure is important because it allows analysts to value the stock based on the price to earnings ratio (or p/e ratio for short)."
I other words, EPS is the "e" in the p/e ratio. So if company A has a p/e ratio of 3 and company B has a p/e ratio of 2, then that tells me that investors will pay more for company A then B even though they have equal profits, which in turn tells me that they see more up-side for company A.
If I'm correct about this then that brings up another issue. If EPS is only used for calculating the p/e ratio, then what's its purpose as a standalone statistic?

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What's With The EPS?

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Sep 09, 2010

Stocks Simplified Writes
by: Shaun

That is correct EPS only matters from an investment standpoint when combined with the P/E ratio. But you need to have it because you cannot calculate the PE ratio without it.

P.S. in your illustration company B would actually be a better investment. The lower the PE ratio the cheaper the company when compared to its earnings and the more upside potential it has.

Sep 09, 2010

What's with the EPS?
by: Gary

You indicate that EPS is necessary for the p/e calculation. Yes, I know that. My question is, why do I care what the EPS value is in and of itself. All I care about is the p/e ratio. So if for example the p/e ratio is 10, I don't care if it's 10 because the share price is 50 and the EPS value is 5 OR if the p/e ratio is 10 because the share price is 40 and the EPS is 4. In other words, Generally,I don't need to know what 2 numbers make the ratio 10, all I care about is what the ratio is. But if you look at a stock page there's a seperate line for the EPS. Since the EPS in and of itself is not important but only part of the p/e ratio equation, why have it presented as a seperate stat? That was my question.
Of course, we do care about the price per share so that being a seperate stat is expected.

As far as which company has more upside; what I meant was that the company with the higher p/e ratio means that people are willing to pay a higher price (relative to the company's EPS), which means that people feel that the company has more potential, otherwise, why would they be willing to pay more (relative to the company's EPS). That's what I meant when I said it has more upside.

Sep 09, 2010

Stocks Simplified Writes
by: Shaun

Your right the EPS doesn’t tell you anything unless it is combined with the P/E ratio. So stop losing sleep over it and move on to what is really important. I don’t know why they tell you the EPS except to help you calculate the P/E ratio or to show you info on how it is calculated.

Now let’s look at the P/E ratio. It is similar to buying a house. If all the average houses in the neighborhood are selling for $100,000 and you find a house that is, average size, average bedroom/bath, etc, and this new house is going on the market for $75,000 wouldn’t that be a great buy?

That is what the P/E ratio attempts to do.
Comparing the ratio with other P/E ratios of different companies in the same industry will help you decide if you are buying the $75,000 house in a neighborhood filled with $100,000 houses or whether you are buying the $150,000 house in the same neighborhood. (except with stocks and industry groups)

The future potential is a different story. If there is a house in the same neighborhood that is selling at $98,000, but they are building a golf course next to it and it will be the only house for sell that will be by the course then ok, it is probably a better investment than the other house that is selling for $75,000 just because the value will go up.

But if not the cheaper house is still the better buy and safer because you never know for sure if that golf course is really going to be built until it does. (just like in the stock market you never know if a company is really going to get that contract or not until it does)

Looking at other things is important too, but strictly from a P/E ratio standpoint the lower the number the better.

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What's With The EPS?

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What's With The EPS?