Earnings per share and Price Earnings Ratio
04/02/2024Earnings 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 pershare 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 pershare 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)

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 pershare 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 pershare earnings. 
Indicates  Company’s profitability on a pershare 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. 