Earnings per share (EPS) is a ratio calculated as a company's profit divided by its number of shares. EPS gives us a clue about a company's profitability: the higher a company's EPS, the more profitable that company is likely to be.
How can I use EPS when I invest in stocks?
- You can use EPS to understand a company's stock price, compare stocks to one another and analyze a company's performance and prospects. As earnings hare positively correlated to the stock price, a higher EPS indicates that the stock has greater value as investors are willing to pay more for a company's shares if they think the company has higher profits relative to its share price. Thus, companies with higher EPS are generally more attractive investments than companies with lower EPS.
- You can use the EPS to calculate the price-to-earnings (P/E) ratio, another common ratio you can look at to determine a stock's valuation. The P/E ratio is derived by using the current stock price divided by the EPS value. Subsequently, you can compare the stock's P/E ratio to the industry average P/E ratio to figure out if the stock is under or overvalued. Intuitively, a higher EPS indicates that the stock has excellent value as it pushes down the P/E ratio, causing the stock to be seen as undervalued compared to the industry average, thus, suggesting it is an excellent long opportunity for value investors.
- However, a low EPS does not always mean that the stock is not a good long opportunity. While a low EPS inflates the P/E ratio of a stock (causing it to seem overvalued), it could also mean that investors expect the company to grow in the future, making it a good investment for growth investors looking to capitalize on capital appreciation.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies