If you want to invest in a company, consider its EPS (earnings per share) number. This number is important because it can show if you will really earn money from investing in that company. What is a good EPS number?
A good EPS number for a company should be at least 25%. That means the company’s stocks should show EPS growth rates not less than 25% compared with its last year’s growth. If a company has this number, it means its products or services are in great demand.
Generally, the EPS number of a company is considered good if its profits are more than the profits generated by its competitors in the same market niche. For instance, Gatorade has a good EPS number because it has captured 75% of the market of sports drinks. It has been dominating its competitors for many decades now.
Read on to learn about what should be considered as a good EPS number for a company, what EPS means, and how you can use it to determine if it’s wise to invest in a certain company or not.
What Is a Good EPS Number?
A company should have at least EPS growth rates of not less than 25% to be considered having a good EPS number. That means its growth rate levels for the current year must be at least 25% more than its growth level of the past year. It would be even better if its EPS growth rate has been increasing in recent quarters and years.
Basically, a company’s EPS number is good if its profits are more than other companies making or selling the same products or services. For instance, Gatorade has been dominating the market of sports drinks for many decades. This PepsiCo brand has captured approximately 75% of this niche market.
In theory, if a company has a higher EPS number, it is more valuable and investment-worthy. It’s easy for investors to know how much money a corporation makes per share of stock they issue by just looking at its EPS ratio. This ratio uses net profits for investment computations.
Factors That Will Help You Determine if the EPS Number Is Good
Several factors can determine if the EPS number of a company is good. These factors include the following:
- The recent performance of the company
- Performance of its competitors
- Expectations of financial analysts who monitor the company’s stock
There are times when a company has reported a growing EPS. However, the stock price might decline if analysts expected a higher number than the company has reported. On the other hand, the EPS number of the company may go down, but it nevertheless leads to a price increase just because analysts were expecting an even lower number.
So, it is always wise to evaluate EPS about the share price of the company. In other words, look at the price-to-earnings ratio or P/E of the company. That means you should also look at its earnings yields, not just at its EPS number.
The Higher the EPS Number of a Company, The More Profitable It Will Be
As a rule of thumb, the higher the EPS number of a company, the more profitable it will be. However, a higher EPS number is not always a guarantee of profitable future performance. You need to consider that the EPS ratio of a company can be affected by how the company reports its expenses and earnings.
If the company only makes minimal changes to its expenses and earnings with its accounting measures, they accurately report their EPS ratio. However, note that EPS skewed ratio calculations can result in huge one-time expenditures or changes to its earnings.
This can happen if the company acquires another business or issues a stock buyback. Both business transactions involve big money. This can result in adjustments to the figures, which can temporarily decrease or increase the company’s EPS ratio.
EPS (Earnings Per Share) Defined
In basic terms, earnings per share or EPS is computed as the company’s profit divided by the outstanding shares of its common stock. The number that comes out will indicate the company’s profitability. It is common for companies to report EPS numbers adjusted for special items and possible share dilution.
So, EPS is a company’s profitability indicator. It is one of many ratios that you can use to gauge the financial health of a company. Another way of computing this number is to deduct its preferred stock from its reported net earnings. And then divide the result that you get by its outstanding shares of stock.
The company’s EPS ratio uses its net profits for computations. In a nutshell, it shows investors how much money it can make per share of stock it issues. So, in theory, a higher EPS would imply that the company is more valuable. If investors are willing to pay a higher price for shares, they are expecting high profits.
Using EPS as your guide to determine the value of a company is certainly logical if you consider that stock prices and earnings often move together. That means, if a company reports higher earnings, then its price per share should also increase accordingly. However, companies can also present their EPS ratios to make them appear financially healthier than they actually are.
The Exact Meaning of EPS
EPS is the acronym for earnings per share. And that is exactly what it means. It is the net income figure of a company that is divided into a per-share basis. In other words, it is the profit of a company for each outstanding share.
To Compute a Company’s EPS
To compute a company’s EPS, you need to get its total net income and then divide it by the number of its shares outstanding. So, the basic formula is:
EPS = Net Income ÷ Outstanding Shares
So, if a company generates a net income of $4,000 for the last quarter, and its outstanding shares are 500, the quarterly EPS of the company is
EPS = $4,000 ÷ 500 = $8
The above is a straightforward way to calculate a company’s EPS. There is a more refined way of computing the EPS. It is the method that is often used in the real world.
This method adjusts the numerator and denominator because you can create shares through options, warrants, or convertible debt. In addition, you can make the numerator more relevant if you will adjust it for continuing operations. The more refined formula is as follows:
EPS = (Net Income – Preferred Dividends) ÷ (End-of-Period Common Shares Outstanding)
To compute the EPs of a company, its income statement and balance sheet are used to find the period-end number of its common shares, the net income or earnings, and the dividends paid on preferred stock. Since the number of shares can change over time, it is more accurate and practical to use a weighted average number of common shares for the reporting term.
Some Samples of EPS
Here are some samples of the EPS calculations of three companies at the end of the fiscal year of 2017.
|Company||Net Income||Preferred Dividends||Weighted Common Shares||Basic EPS|
|Bank of America||$18.23 billion||$1.61 billion||10.2 billion||($18.23 – $1.61)/10.2 = $1.63|
|Ford||$7.6 billion||$0||3.98 billion||$7.6/3.98 = $1.91|
|NVIDIA||$3.05 billion||$0||0.599 billion||$3.05/0.599 = $5.09|
How to Use EPS
Experienced investors are experts in using EPS in choosing the companies where they will put their money. It is one of their most important metrics for gauging a company’s profitability based on absolutes.
Calculate P/E Ratio
The EPS of a company is also very useful to investors in calculating its price-to-earnings valuation or P/E ratio, where the E represents the EPS. If they divide the company’s share price by its earnings per share, they can see its stock value based on how much the market is willing to pay for every dollar of its earnings.
Indicator of the Viability of Its Stocks
You can use a company’s EPS as an indicator of the viability of its stocks. To ordinary shareholders, comparing the EPS of different companies in absolute terms may not seem very important. They don’t have direct access to the company’s earnings, that’s why.
They would rather compare EPS with the stock’s share price to evaluate the value of earnings and how investors feel about its future growth. But when comparing different stocks, it will be wise to use the EPS ratio as your guide.
Years of EPS Growth Signify Profits and Earnings
If a company is recording continued year-over-year growth in EPS, it could signify that it has the potential to sustain profits and earnings over time. On the other hand, if you see that the company’s EPS is on a downward trend or posting negative EPS, it could get stuck with the pattern of losing money.
Besides EPS, you should also consider other ways of measuring the financial health of a company. Take a look at its price-to-earnings ratio as well. This metric measures the value of the company about its EPS. The higher its P/E ratio, the higher is its expected earnings.
However, always keep in mind that this is not a guarantee the company’s performance can meet or exceed expectations. It could also imply that a higher P/E ratio means the company is overvalued.
The point is the more metrics you use, the better you will be able to gauge a company’s fiscal health. Considering a company’s EPS, P/E ratio, and other metrics will help you avoid value traps. You can encounter value traps when you think a company is undervalued when it is not.
Evaluating A Company’s EPS Number
Comparing one company’s EPS to another is very subjective. It can vary from one industry sector to another. It is better to use EPS to compare ratios across similar businesses within the same industry sector while simultaneously examining the historical trends. Additionally, market and investor expectations also influence profitability measures:
1. Look at How the Company Reports Its EPS Over Time
You also need to see the trend of how a company is reporting its EPS over time. If the company has steadily reported increasing EPS over a period of time, say over several quarters or several years. It could mean that investing in that company is really profitable.
However, if the EPS ratios of the company have experienced sharp increases or sharp decreases over time, that could imply that its profitability is unstable, which may also mean it is not sustainable.
2. Compare Companies Within the Same Market
To get a good EPS number, you need to compare companies across the same industry sector. In that way, you can better gauge what a good EPS number is for that market niche. Look at competing companies using the same business models.
Then look at how their individual EPS ratios have trended or acted over time. If a company always outperforms another company in profitability, use that as a benchmark for a good EPS number.
3. Look at the Broader Economic Picture
EPS reporting can be significantly affected by the changes in the economy. When there is a recession or an economic downturn, every individual industry sector of the market will experience different consequences.
For example, during a recession, consumer discretionary spending will dive while consumer staples will see a boost. So, this situation will positively affect consumer staples while negatively affecting discretionary products such as tourism, travel, hospitality, and similar industries. In other words, EPS reporting in both industry sectors will be affected.
4. Look at How the EPS Matched Market Expectations
A company that could satisfy or even exceeded expectations for earnings means it is reporting its EPS accurately. However, if its earnings fall short of what is expected, it could mean its EPS reporting is not accurate.
Conclusion: What Is a Good EPS?
To be considered good, the EPS number of a company should be no less than 25%. In simple terms, it means that the company’s stocks should show EPS growth rates of at least 25% more than its growth rate for the past year.
If the company exhibited this minimum growth rate, its products and services are in great demand. It would be even better if the growth rate of its EPS rate has been increasing in recent quarters and years.