Earnings per share and Price Earnings Ratio

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)​

• 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.