Stock Analysis – Earnings Per Share & Price to Earnings Ratio

August 13, 2009

Stock Analysis Series

In the world of financial investing, there are many different types of analysis that people look at in judging the health and value of a company and its stock. Over the course of the stock analysis series we’ll explain what these methods are and how you can use them to evaluate your investments. This article will cover Earnings Per Share (EPS) and Price to Earnings Ratio (P/E).

Earnings Per Share (EPS)

When comparing two stocks, it isn’t as simple as comparing the stock price or the total earnings of each. There are too many variables that make these comparisons unfair and unrealistic. One way to get a clearer view is the use of Earnings Per Share.

EPS = net earnings/outstanding shares.

If the number of shares have changed during the period calculated (share buyback, stock dividend, etc.), a weighted average is used for outstanding shares.

Some fact sheets will show three different versions of EPS:

  • Trailing EPS – based on previous fiscal year; only true EPS
  • Current EPS – current year’s information; actually projections
  • Forward EPS – looking out to future numbers; projections

When looking at EPS for a company, please keep in mind that there may be one-time events that could affect the number for a given period. If you see a spike in one direction or another, take a deeper look at why. Ultimately, you want to find a company that has and EPS that has trended upward over a period of time.

Price to Earnings Ratio (P/E)

Like the EPS, the P/E of a stock is one of the most popular pieces of analysis used by investors. This is also one of the pieces of information that “CNBC trained” investors often base their whole trading philosophy on. If it were only that easy…

P/E = stock price/EPS

A high P/E can mean one of two things: the market has confidence in the stock and believes the price will go up, or that it is over-priced and ready for a drop. A low P/E could a down and out stock or a Warren Buffett gem.

Be careful when using P/E to compare two different stocks, specifically when they are from different sectors. You could be looking at one stock that has a P/E of 25 where the sector average is 30. The other stock could have a P/E of 14 where the average is 10 in its sector. Using just P/E to analyze these stocks, which one do you think is a better investment? Are you sure???

Evaluating Stocks

Earnings per share and price to earnings ratio are the two most popular pieces of analysis for DIY investors, but they are NOT the only ones. They only tell part of the story. By all means use them, just remember there are other factors out there that can have an impact on a stock’s price.

Next time I’ll cover using price to earnings growth, debt to asset ratio, and dividend yield for stock analysis.  If you’d like to have the rest of the stock analysis series sent to you click here to subscribe to free updates.


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