When deciding where to invest your money, there are different ratios you can use to find the right companies to back. One of them is earnings per share (EPS), which is one way to measure a company’s profitability. The higher this number, the more profitable a company is likely to be. But what is a good EPS and what influences a particular company’s ratios? Asking those kinds of questions can help you better evaluate a company and its profit potential when deciding whether to add it to your investment portfolio.
Earnings Per Share, Definition
EPS is a profitability indicator and it’s just one of several ratios that can be used to gauge a company’s financial health. To find EPS, you would simply divide a company’s reported net income after tax minus its preferred stock dividends by its outstanding shares of stock.
The EPS ratio uses net profits for calculations and, in a nutshell, it tells investors at a glance how much money a company makes per share of stock issued. In theory, a higher EPS would suggest that a company is more valuable. If investors are comfortable paying a higher price for shares, then that could reflect strong profits or expectations of high profits.
Using EPS as a guide for determining a company’s value has a certain logic since earnings and stock prices often move in tandem. Meaning, that if a company posts higher earnings then its per-share price should increase accordingly. But EPS ratios can sometimes be molded to make a company appear financially healthier than it really is.
What Is a Good EPS?
EPS and what qualifies as a good EPS is dependent largely upon the company itself and market expectations of how well that company will perform. As a general rule, the higher a company’s EPS, the more profitable it’s likely to be, though a higher EPS isn’t a guarantee of future performance.
It’s important to remember that the quality and reliability of a company’s EPS ratio can be influenced by how the company reports earnings and expenses. If a company makes minimal adjustments to earnings or expenses with its accounting measures, then that could suggest the EPS ratio being reported is accurate.
On the other hand, if a company reports large one-time expenditures or adjustments to earnings that can skew the EPS ratio calculations. For example, if a company issues a stock buyback or acquires another company that can result in adjustments to the numbers that can temporarily increase or decrease the EPS ratio. Taking on large amounts of debt can also lead to manipulation of the numbers.
How to Evaluate EPS
What is a good EPS ratio for one company versus another is subjective and it can vary from one industry to another. A better way to utilize EPS when evaluating companies is to compare ratios across similar companies within the same industry while also looking at historical trends. And it’s important to keep in mind that investor and market expectations can also affect profitability measures.
Making EPS comparisons across companies within the same industry or sector that are similar can give you a framework for determining what is a good EPS. If you have two competing companies with similar business models, for example, you can look at how the EPS ratios for each one have trended over time. If one company consistently outperforms the other when it comes to profitability, you could use its EPS as a benchmark for what is a good EPS.
You can also look at individual trends to see how a company’s reported EPS has changed over time. A company that has a steady track record of reporting increasing EPS ratios quarter over quarter or year over year could signal that it’s profitable and that its stock price is likely to continue increasing. When EPS ratios undergo sharp increases or decreases, on the other hand, that could suggest that a company’s profitability is less stable or sustainable.
Something else to consider when using EPS to compare companies is how reported EPS matches up with market expectations. If a company meets or exceeds expectations for earnings then it may be safe to assume its EPS is being reported accurately. If, on the other hand, earnings fall far short of expectations that could prompt taking a closer look at EPS and other ratios to gauge how accurate the numbers are.
Finally, consider the broader economic picture when trying to determine what is a good EPS for any given company. When a market downturn or recession happens it can have different consequences for individual sectors of the market. In a recessionary environment, for instance, consumer staples might see a boost while consumer discretionary spending takes a dip. That can have a ripple effect on specific industries, such as travel, tourism and hospitality, all of which can affect EPS reporting.
Using EPS to Choose Stocks
When comparing different stocks, it’s helpful to use the EPS ratio as a guide. If a company is posting year over year continued EPS growth, that could be a sign that it can sustain profits over time. Conversely, if a company has a downward trending EPS or is reporting a negative EPS, that could indicate that it’s stuck in a pattern of losing money.
Aside from EPS, however, remember to consider other measures of financial health. Price to earnings ratio, for example, measures a company’s price relative to its EPS. The higher a company’s P/E ratio, suggests that higher earnings are expected. But again, this isn’t a guarantee that a company’s performance will meet or exceed expectations. And a higher price to earnings ratio could also suggest that a company is overvalued.
The more metrics you use to compare stocks, the more accurate a picture of its health you may be able to create. Looking closely at EPS, price to earnings and other measures can also help you spot and avoid value traps if you follow a value investing strategy. Value traps occur when a company appears to be undervalued but in reality, it isn’t.
The Bottom Line
There’s no fixed answer for what is a good EPS. When comparing companies, it’s helpful to look closely at how EPS is trending and how it matches up to competitor earnings. Remember that a higher EPS can suggest growth and stock price increases – though they don’t guarantee it.
Tips for Investing
Consider talking to a financial advisor about EPS and other ways to measure the profitability and financial health of companies. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool can help. By answering a few simple questions, you can get personalized recommendations for professional advisors in your local area. If you’re ready, get started now.
Choosing companies with a solid EPS ratio could mean future growth in your profitability. But keep in mind that if your portfolio’s value increases, you may owe capital gains tax when you sell those investments. If you’re concerned about getting hit with a big tax bill, you can use SmartAsset’s capital gains tax calculator to estimate how much you may owe when it’s time to sell.
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