One of the most useful statistics to look at when trying to judge the value of a company is Earnings Per Share (EPS). It’s not the only bit of information you’ll need to make an informed decision about a company – and it is only truly useful when studied over time rather than as a one-off figure – but it’s still a good place to start.
Consider it a bit like the price tag on a used car – it’s a snap-shot of what the car is currently judged to be worth, but it doesn’t mean much on its own until you’ve had a look under the hood (literally and figuratively) and researched the milage and service history.
A company’s EPS – in its simplest form – tells you how profitable that company is
Company profits are divided by the outstanding number of shares in that company, and the resulting number is the EPS. For example – if a company has $10 billion in profit and there are 5 billion outstanding shares in that company, then EPS is $2 (10 billion divided by 5 billion).
There are 2 types of EPS – basic and diluted. Basic EPS is calculated according to the formula above, whereas diluted EPS – takes into account the fact that a company may dilute shares by giving them to employees or restricting stock units. Diluted EPS takes all shares into account and if there’s a big discrepancy between the outstanding shares and those allocated elsewhere, it will have a big effect on EPS.
Companies report EPS every quarter so it’s a good gauge of the short term share price for that business, but it doesn’t tell the full story; a company’s EPS can be manipulated and can be deceptive, so here are a few things to bear in mind when looking at it.
Firstly, the EPS as a one-off number only tells the recent part of the story
The company may be affected according to the time of year, or it may have experienced an“extraordinary item” – business speak for an event which is not part of the company’s normal functioning. The company may have sold an asset such as a piece of land, or it may have had an unexpected cost to pay. Either event would change the EPS in the short term but wouldn’t materially affect the value of that company. If the EPS is far lower or higher than recent patterns would suggest, dig a little deeper to find out why.
The EPS is also open to manipulation
A company may buy back some of its own shares, thereby decreasing the number of outstanding shares and sending the EPS up, despite there being no increase in profit.
You also need to consider the fact that EPS tells you nothing about either debt or efficiency
If either is wide of the mark, that’s an issue, but not one which EPS would convey. Essentially EPS is a growth indicator – look at it and cash flow overtime to figure out whether a company is as sound as it initially appears.