How to use EPS to evaluate stocks
E*TRADE from Morgan Stanley03/02/21
Earnings per share, or EPS, is a way to express a company's profits in terms of each stock share owned by its investors. EPS can help an investor make sense of a stock's price, compare stocks to one another, and analyze a company's performance and prospects.
What is EPS?
If you follow stocks and the market, one figure you'll see mentioned all the time is EPS. Earnings per share tells you about the profitability of a company in a way that's particularly useful to investors trying to judge whether to buy or sell individual stocks.
EPS is a company's net earnings (i.e., net profits) for a given time period divided by the number of shares of its stock outstanding. For example, if XYZ Corporation made $100, and there are 100 shares of its stock, the company’s earnings per share is $1.
EPS figures can be represented over different time periods. A very common figure known as trailing EPS, for example, is calculated using the company's net earnings for the previous 12 months.
It's also important to know what is included in the number of shares. Basic EPS is determined using so-called "free float," or the number of active company shares in the market. Diluted EPS, on the other hand, is determined using free float plus convertible instruments, such as stock options granted to employees that may become common shares in the future. Because it typically includes more shares, diluted EPS usually will be lower than basic EPS.
What does EPS indicate to an investor?
When comparing the earnings per share of different stocks, it's important to compare companies only within the same industry or sector. EPS helps show how well a company generates profits for every dollar that shareholders invest and can be a significant factor influencing a stock's price.
Investors might also look at EPS for a single stock over time to help gauge a company's trajectory. Is EPS growing from quarter to quarter or shrinking?
If a company's EPS is higher than that of its competitors, or on an upward trend, that may be a sign that the company can increase dividend payments or invest more to grow its business.
Earnings per share is used to calculate another key stock analysis figure: price to earnings ratio, or P/E ratio. The P/E ratio is a good indicator of the health of a company as expressed through earnings. This is calculated by dividing the stock price by EPS. If the market price of our XYZ Corporation stock is $15 when the company's EPS is $1, then the P/E ratio is 15. The stock is selling for 15X more than its earnings per share. An investor might use this to help judge whether a stock is overpriced or underpriced, or to compare the performance of stocks within the same industry
Investors might also look at EPS for a single stock over time to help gauge a company's trajectory.