What does EPS tell us about a company.?
I understand how EPS is calculated. But I still don't udnerstand exactly what it tells me about a company.
Say Company A and B both have $10M in net earning.
Company A has 5M outstanding shares (EPS of $2)
Company B has 10M outstanding shares (EPS of $1)
What is the importance of the number of outstanding shares? Both companies had the same net earnings-so why does it matter how many shares of stock they have outstanding?
Finally, how does this effect the stocks price? Is it simply because when this number is released that people arrive at an opinion of the company, which leads to the prices going up or down? Or is the actual price of a company partially dependent on the EPS?
I'm trying to be as clear as I can with my question, if any clarity is needed, I will leave it as a follow up.
Thanks again.
Answer:
The number of shares outstanding is important because stock prices are based (at least in part) by the EPS. Look at it this way.The more you dilute the value of each share and thereby lowering the EPS, the less valuable each piece (or share of stock) becomes. Therefore, with all things being equal, the stock price of Company A should be twice that of Company B.
To simplify it, lets say that you own 10,000 shares of each company, and they each pay shareholders 10% of the EPS as a dividend. You would get $2000 from Company A and $1000 from Company B. Now if you could own only 1, which would you pick?
Note: this is an overly simplified example and EPS is not by any means the sole metric to measure a stock's value against, nor is if they pay a dividend or not.
EPS is a tool for comparison. Obviously the more shares of a company that out, the more diluted your holdings are. As with any statistic, you have look at more than just one number to make a good judgement on a company.
Its a way to break dow how much a company is valued as compared to another company and come into play when looking at the simple valuation of the PE-price per earinings ratio of a company.
For example: Company A an EPS of $2 and stock price of $20 the PE of the company would be 20/2=10
Now a similar Company B has an EPS of 1$ and a stock price of $20 the PE of company B would be 20/1=20
So company B is twice as expensive as Company A with regards to the stock price.
So if you are trying to do a simple valuation of the stock price of companies you can just look at the PE rather than calculating the market cap, #of shares etc but to calcualte the PE you need to know the earnings per share.
Let me ask you this: Would you rather own 5% of a company or 10% of a company? That is the difference that outstanding shares represent.
Common stock ownership represents ownership in the net assets of the company. The EPS represents your theoretical share of the earnings of that company. For every share you have "earned" or you "own" $2 of earnings in Company A and $1 in company B.
The earnings of a company does factor into the price of the stock. Most stocks are priced according to a price / earnings ratio. It is the amount of $$ a person is willing to pay for the earnings of that company. Many factors goes into driving what that ratio is for a particular company, but if all things are equal (industry, revenue growth rates, earning growth rates), then the PEs should be similar.
In your example, if Co. A is trading @ $25 per share, the PE is 12.5 (25/2). If Co. B is also trading @ $25 per share, the PE is 25.0 (25/1). For whatever reason, the purchasers of company B shares are valuing the company at 2x the value of company A (in this example). Again, under normal circumstances and all other items being equal (and they never are), Company B should be trading around 12.50 per share if the industry norm is a PE of 12.5.
This PE of stocks and industries adjust over time and vary with supply and demand of equities, interest rates and other macro economic factors (inflation, GDP, etc.).
This is a really simplistic explanation of EPS. Some research on wikipedia couldn't hurt of you want to explore it more.
http://en.wikipedia.org/wiki/p/e_ratio#d.
Say Company A and B both have $10M in net earning.
Company A has 5M outstanding shares (EPS of $2)
Company B has 10M outstanding shares (EPS of $1)
EPS determines & impacts on the price of the share.
With the above
information, you can easily know that the price of each
share in Company B will be half the price of a share
of Company A.
EPS is used to compare among enterprises in the same industry.
For example:
If IBM has EPS = $4 and a price 10X = $40 per share
& DELL has EPS =$4 and a price 8X = $32 per share
you might say that IBM could be a little bit overpriced
because its EPS multiplier is 10X in the market.
So if both companies were in your opinion very much alike, you would envision DELL's shares rising in price or IBM's shares
dropping in price.
By itself, EPS is meaningless. You need to use other numbers as well.
Value investors compare EPS to the stock price and buy companies with low P/E (price/earnings) ratio.
Growth investors compare most recent EPS to historical EPS and buy companies that show good growth. Often, they use a PEG (price-earnings-growth) ratio. Price/earnings ratio is divided by the expected EPS growth, and stocks with the lowest PEG ratios are bought.
Contrarian investors compare most recent EPS to historical EPS and buy companies that had unusually low EPS lately. (The idea is that the company will eventually recover from this one-time slump.)
Momentum investors compare actual EPS to EPS estimates made by analysts and buy stocks which show positive earnings surprises (actial EPS are higher than expected).
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