EPS ratio definition includes one of the essential tools used to evaluate a company and make investment decisions. The EPS indicates how much net profit a company earns per share (we are talking about ordinary shares). EPS is, by its nature, a kind of indicator of the company’s profitability.
Explanation:
In the fundamental analysis, there is a revenue multiplier (a financial coefficient that compares various performance indicators of a company with the income it earns), which is called EPS. Earnings per share (EPS) ratio is an incredibly important criterion for determining investment performance. EPS ratio formula is defined as an economic multiplier that represents the ratio of an organization’s net profit to the number of shares.
EPS = net incomeaverage / number of shares
The numerator shows a net profit, which is equal to the same indicator in the report. In some versions of EPS, for example, in the weighted index, dividends on preferred shares are deducted from profit.
The denominator is the average number of shares, the calculation of which takes into account absolutely all changes that occurred during that period. Thus, EPS shows how much profit per share, while the indicator can be harmful. In the latter case, it will no longer be a question of profit, but of a loss per share.
The value of EPS shows what fluctuations in the profitability of the company should be expected shortly. If the EPS was calculated, only taking into account the shares in circulation at the moment, it is common to call the EPS basic. To calculate the possible impact of dilution, you need to calculate a diluted EPS.
In calculating this calculation, all equity convertible securities are analyzed as if they have already been converted. In this case, both additional shares that have appeared, and the additional profitability of the company are taken into account.
EPS is quite popular when comparing the investment attractiveness of companies in the stock market. It often represents an essential foundation in investment strategies. It should be noted that the EPS cannot be used to compare the instantaneous investment efficiency of companies. The company, which is an international conglomerate, profit per share, can be tens and hundreds of times lower than that of any regional company.
Then you can ask a logical question about the need to introduce such a coefficient. As a rule, the EPS model is used in recalculation for a calendar year so that you can see the dynamics of profit per share. When comparing companies, higher earnings per share usually allows one to determine the favorite, and comparison of the current performance of the company with earlier periods reflects the dynamics of its business.
EPS provides useful guidance on possible price movements. But, as with all fundamental indicators, it should be perceived in dynamics, in comparison with the companies-colleagues in the industry.
The main drawback of the method is how much the company is already undervalued/overvalued: investors can buy shares in the hope of more aggressive profit growth, “laying down” on the significant values of EPS in the future. The EPS explains the formation of a view of only one firm’s performance about the performance of another firm or concerning the performance of a particular business area as a whole.
However, the calculation of EPS does not make it possible to understand whether a company is undervalued or overvalued. To make a wise investment decision, indicators such as market capitalization, share value, dividend amount, availability or absence of long-term economic prospects and liquidity level must also be calculated.