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Earnings Per Share answers 2 primary questions you as an investor will have. How much profit does the company make, and, how much of the profit is accrued to you as a shareholder?
Once these questions are answered, you can get on with the business of determining how much you are willing to pay for the company stock, based on the multiples (P/E ratio – PE ratio definition) prevalent in the industry.
What is Earnings Per Share?
Earnings per share can be defined as a company’s profit that is allocated to every outstanding share of a common stock. It is an indicator of a company’s profitability, making it easy to project if they are doing well, or could be in trouble. By itself, the EPS value does not say anything about the attractiveness (or lack) of the stock.
How to Calculate Earnings Per Share?
Mathematically,
Earnings Per Share (EPS) Ratio = Net Income Attributable to the Common Stockholders / Number of Common Shares Outstanding
If there are no preferred stock outstanding (see: preferred stock vs common stock), the Net Income value can be used. If there are preferred shares outstanding, the preferred stock holders are paid dividends before any of the income reaches the common stock, and therefore, the EPS calculation adjusts for this
See also: what is a good PEG ratio
What to Consider in Earnings Per Share Analysis?
Whether the Earnings per Share is higher or lower in any one given period is not very informative for judging the value of a stock. Of course, a negative number represents a loss, so this should be considered.
Consider the following 2 cases:
1. Berkshire Hathaway has an EPS of almost $14,000 today with it’s A shares, and only about 770,000 shares outstanding. Its B shares have $9 EPS with about 1.3 Billion of such shares outstanding. These are both interconvertible and represent the shares that are equivalent, except for the size of the equity claim they have over the business
2. Same EPS for two different companies from different industries may actually translate in differing stock prices because of the individual industry characteristics. Auto manufacturers, for example, tend to trade at lower multiples of their EPS, while a Semiconductor company may trade at a multiple that is significantly higher
In addition to the multiples of the EPS, we also want to consider how the EPS has changed over the number of quarters or years. A company that is growing its EPS, could potentially be a growing company (It could also be just shrinking its share count by repurchasing it). If the investor continue to pay similar multiples of Earnings per Share in the future, a growing company will grow its stock price, and therefore could be a great investment.