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If you're an investor, it's important to do your due diligence on a company before you invest in its stock. One way to do this is by looking at the company's earnings per share in recent quarterly reports.
Earnings per share (EPS) is a measure of a company's profitability and effectively tells you how much profit a company earned in a given period per share of outstanding common stock.
Here's a quick overview of how EPS works and how investors can use it when making investing decisions.
Earnings Per Share Formula
Earnings per share is calculated by dividing a public company's quarterly or annual profits by the number of outstanding shares of its common stock, which is the type of stock most investors have.
For example, let's say a company has $100 million in quarterly earnings and has 50 million outstanding shares. You'll divide $100 million by 50 million to get a $2 EPS. If the company has preferred dividends it must pay out, you'd subtract those from the earnings.
A high EPS means that the company performed well during the earnings period, and investors are willing to pay more for its shares, making it more valuable to existing investors. That said, a low EPS isn't necessarily a bad thing, and investors should consider several pieces of information to make an informed decision about an investment.
How to Use Earnings Per Share
A company's EPS gives investors an easy indication of whether the company is profitable. If you're considering investing in a company's stock, you'll want to look at the most recent earnings reports from the past several quarters to get a good idea of which direction the company is trending financially.
If a company has had strong EPS growth, it could be a sign that it's worth investing in. On the flip side, a downward trend could mean that you should think twice or at least do more research to find out why.
In addition to the company's reported earnings per share, it's also a good idea to look at what stock analysts estimated the EPS to be. If a company reports a solid EPS, but it comes in lower than the consensus analyst estimate, that means that while the company performed well, it didn't meet the expectations of the market, and the stock price may remain the same or even drop.
While EPS is a popular metric for investors, it's best used in conjunction with others. The price-to-earnings (P/E) ratio is one example and is calculated by dividing the company's stock price by its earnings per share. For example, if the company in the previous example has a stock price of $20, its P/E ratio is 10.
Considering the average P/E ratio is generally between 13 and 15 for the S&P 500, a major stock index, a P/E ratio of 10 could be a sign that the stock is undervalued and has some upside potential for investors.
But these are just two metrics you can use to assess whether a stock is worth investing in. It's a good idea to research other measures or even enlist the help of a financial advisor to help you with your investment strategy and analysis.
Basic EPS vs. Diluted EPS
If you're reading about a company's earnings report, you'll likely come across the term "diluted EPS." This figure takes into account other securities that could be converted into common stock, such as stock options, convertible shares of preferred stock, convertible bonds and warrants.
If all of these securities were converted into common stock, it would increase the total number of shares outstanding and decrease the company's EPS.
Now, let's say that the company in the example above has 50 million shares of common stock, 10 million stock options and 20 million convertible shares of preferred stock. You'd divide $100 million by 80 million shares to get a diluted EPS of $1.25.
While it's unlikely that all owners of convertible securities would convert to common stock at once, this figure gives you a more conservative look at the company's profitability. Understanding both can help better inform your stock choices.
What Is a Good EPS?
There's no hard-and-fast rule for what a company's EPS should look like. Instead, it's important to consider a company's profitability in context.
For starters, did the company report a higher EPS than what analysts estimated? If so, it's generally considered to be a good sign. That's especially true if the company has seen good EPS growth over the last several quarters.
You'll also want to compare the company's EPS with its competitors'. For example, if you're thinking about buying Bank of America stock, you'll want to compare the bank's EPS to that of other big banks, such as JPMorgan Chase or Citi.
Even if a company has a negative EPS, which means it's losing money, the stock may still be worth buying. In the case of Amazon, for example, the company had a negative EPS for a long period of time, but its stock price still increased because of other indicators, including its massive market share. The company only had negative earnings because it was investing so heavily in growth.
Take the Time to Learn Before You Start Investing
Investing in stocks and other securities can be a risky endeavor, especially if you're a beginner. While it's possible to net big returns in a short period of time, you could end up losing money if you're cavalier about your approach.
To invest in stocks, you'll need a brokerage account. When you compare brokerage accounts, consider the resources and tools each one offers to help you make educated investment decisions. You'll also want to learn from investing experts and even consider hiring a financial advisor. Even if you decide not to have them invest on your behalf, a good advisor can help you make more informed and objective decisions about your investment portfolio.