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EPS (Earnings Per Share) is typically listed along with what seems to be much more insightful metrics for equities.

Is EPS useful in it's own right, or does one need to plug it in to an equation to make it useful?

Let's create a simplified example to examine this:

Let's first look at fictional company ABC. Their total earnings are €100 per annum. 100% of their company is divided into 5 shares. Thus, the EPS will be €20.

Now, let's compare that to fictional company XYZ. Their total earnings are €100 per annum. 100% of their company is divided into 10 shares. Thus, their EPS will be €10.

The EPS of ABC is 2x that of XYZ, but the earnings of both companies are identical. Thus, it seems like EPS, unless plugged into a formula, is almost meaningless. By itself, the only real value seems to be if it is positive or negative.

How does one use EPS as a valuable tool in evaluating an equity?

Amazon Dies In Darkness
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2 Answers2

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The EPS number is valuable as it tells you the earnings you get per share as a shareholder. If you owned the whole company then it would not matter but since a shareholder owns a fraction of the company it matters how much (hypothetically) you own from the earnings.

In your example, it is true that both companies earn $100 in total, but if you own 1 share of ABC you as a shareholder own 20% of the earnings of ABC and therefore if all the earnings were to be distributed you will get $20. If you had owned 1 share of XYZ you will own only 10% of the earnings and therefore have a claim to $10 of the earnings.

So in the case of the XYZ company, you will have to own twice as many shares to get the claim to the same amount as ABC. Now if the price of both company’s shares is identical, it is obvious that buying 1 share of ABC is a much better value than buying 1 share of XYZ.

It makes it more intuitive if you imagine that all the earnings are distributed at the end of the year as a dividend to shareholders. Therefore EPS become DPS (Dividend per share) and you as a shareholder get DPS multiplied by the number of shares you own of the company.

Dbrooks
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You are correct that EPS by itself is not useful - but just "plugging it into a formula" does not always help either. There is a lot of context behind an individual company's earnings that need to be considered as well.

The most common use of EPS is to compare it to the stock price ("P/E Ratio"). That tells you how much you're paying for those earnings (or, how "cheap" a stock is compared to its earning potential). But even that is not always enough to completely evaluate a company.

How consistent are the earnings? How much are they growing? Are there irregular ("non-recurring") expenses or revenues that are skewing the earnings? Are there "creative accounting" measures taking place that may skew the earnings? How do the earnings compare to other similar companies?

All of those are additional questions that should be evaluated as well. Not all of them are completely quantifiable, either.

D Stanley
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