by Earnings Per Share (EPS)
Earnings Per Share (EPS) is a financial ratio that measures the portion of a company’s profit allocated to each outstanding share of common stock. It serves as an indicator of a company’s profitability and is widely used by analysts and investors to gauge the financial health of a company.
Calculation:
EPS = Net Income − Dividends on Preferred Stock / Average Outstanding Shares
Where:
- Net Income:
The total profit of the company after all expenses, taxes, and interest have been deducted.
-
Dividends on Preferred Stock:
Amount that must be paid out to preferred shareholders. This is subtracted because EPS only pertains to the earnings available to common shareholders.
-
Average Outstanding Shares:
The average number of shares that were outstanding during the period, taking into account any changes in the share count.
Use:
EPS is a crucial metric in assessing a company’s profitability on a per-share basis. It helps investors determine how much profit the company is making for each share they own, facilitating comparisons between companies and across industries.
Price Earnings Ratio (P/E Ratio)
The Price Earnings Ratio, or P/E Ratio, is a valuation ratio of a company’s current share price compared to its per-share earnings. It indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings.
Calculation:
P/E Ratio = Market Value per Share / Earnings per Share (EPS)
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Market Value per Share:
The current trading price of the company’s stock.
-
Earnings per Share (EPS):
Calculated as described above.
Use:
The P/E Ratio is used by investors and analysts to determine the market’s valuation of a company relative to its earnings. A higher P/E ratio might indicate that the company’s stock is overvalued, or investors are expecting high growth rates in the future. Conversely, a lower P/E ratio might suggest that the company is undervalued or that the market expects slower growth.
Relationship Between EPS and P/E Ratio
EPS and P/E Ratio are closely related, with EPS serving as a critical component in calculating the P/E Ratio. While EPS provides a measure of a company’s profitability on a per-share basis, the P/E Ratio uses that information to assess the company’s value in the eyes of the market. Together, these metrics offer a comprehensive view of a company’s financial health, profitability, and market valuation, aiding investors in making informed decisions.
| Aspect | Earnings Per Share (EPS) | Price Earnings Ratio (P/E Ratio) |
| Definition | Measures the portion of a company’s profit allocated to each outstanding share of stock. | Valuation ratio comparing a company’s share price to its per-share earnings. |
| Indicates | Company’s profitability on a per-share basis. | How much the market is willing to pay for each dollar of earnings. |
| Use for Investors | Assess profitability and earnings trend over time. | Evaluate if a stock is overvalued, undervalued, or fairly valued relative to earnings. |
| Interpretation | Higher EPS indicates higher profitability. | Higher P/E suggests higher future growth expectations or potential overvaluation. Lower P/E may indicate undervaluation or lower growth expectations. |
| Dependency | – | Depends on EPS to calculate. |
| Value Type | Absolute value showing earnings attributable to each share. | Relative value comparing market perception to actual earnings. |
