EPS, or earning per share, is calculated as
EPS = Net Income
Average Outstanding shares
and is used to describe the profitability of a company’s profit contributed to by each share of the common outstanding stock of the company. Basically, it represents the profit made per share. More than the physical value of EPS, the rate at which EPS grows is more important.
The term ‘outstanding stock’ or outstanding shares refers to those shares which are held by the officers of the company or by the general public. Outstanding shares do not include shares which might have been brought back by the company.
For instance, if the company has earned a profit of $10million and has 2 million outstanding shares in the market, then the EPS would be $5. This is an important figure and allows to estimate the actual cost of the share using P/E ratios.
More important than the EPS value is the growth rate at which the EPS grows. Suppose a stock has an EPS of $.20, while another stock has an EPS of $, then it is obviously better to bet your hands on the second stock having a higher EPS. But, there is a catch here. Suppose, the consequent year, the first stock generates an EPS of $.30 while the second stock generates the EPS of $1.05, then it is quite visible that the first stock is growing at a much faster rate than the second one, hence, the first stock becomes a preferred option for those looking forward to a sustained growth on a YoY basis. The first stock, therefore, grows at a rate of 50%, while the second one only shows a growth rate of 5%, hence the former is a better option to go for.
Another aspect to be looked at while carrying out comparative analysis between two stocks is that, if the EPS of a share is high, then its stock price is also high. In our example, the market rate of the second share was higher than the first share. Therefore, for those seeking to invest in a growing company’s share, the first option is definitely the one to look out for.
In order to get a fair idea of the EPS growth rate, it is better to look at the data for the previous 5-10 years. An EPS growth rate of about 15% is a fair enough number. If you are looking for consistency, then your target company ought to pass this acid test. Checking for consistency is the only way in which one can ensure that they have minimized the risk involved in the investment. Not all companies are capable enough of maintaining a 15% growth rate over a long term and such companies, should therefore, be ignored.
Companies with a high EPS rate over a number of years should be invested in. This growth rate should be considered over a prolonged time-span.