Earning per share (EPS) is a basic requirement in calculating the price to earnings ratio, the go to metric for investors in taking a simple valuation of a company’s equity. As the owner of the stock which is a portion of the business. The EPS number shows essentially how much of the business income shareholders receives per share.
Also it is used in Price Earning Ratio metric in understanding where the company is trading relative to the market or competitors in the industry.
Earning Per Share Forumla
Earning Per Share = Total Earnings / Shares Outstanding
EPS is calculated by dividing the total earnings or net profit of the company by shares outstanding.
It is similar to Dividend per share where instead the total dividends declared by the board of directors are divided by the shares outstanding.
For better or worse, Analyst estimates of companies are primarily focused on the next quarter or next year’s EPS. A number of assumptions are made during the investment analysis where critical assumptions are established, such as rate of revenue growth, forward commodity prices like gold, iron ore or LNG price if the company is a commodity producer as well as the expected expenses margin.
As all road leads to Rome. All inputs leads to next quarter, year EPS number as well as the rate of EPS growth.
Price to Earnings (P/E)
EPS is used to calculate the price to earning ratio. The P/E ratio simplifies how many years of current earning are investors willing to pay today. Price to earnings ratio can reflect the markets view on the future potential of the company however it is imprecise. As investors bid up higher growth companies, its p/e would rise above market while those with business models are struggling against competitors can trade at a discount to market.
Our list of companies to buy today are primarily focused value area which are normally low p/e ratios relative to market. However do have high p/e stocks like Paypal and Wholefoods where we like the growth potential.
Cashflow Per Share
In addition to the above metric we like to focus on the cash flow per share number for companies. Similar to how EPS is calculated, cash flow per share is using the total free cash flow and divide by the shares outstanding. This gives a better picture of the cash flow generation ability of the business. One proxy for cash flow is EBITDA.
Earnings before interest, tax, depreciation and amortization (EBTIDA) is commonly used as a proxy for cash flow for the business. We don’t like to use this metric as it ignores some critical factors like interest and taxes. After all shareholder only receives the money after the company has paid interest and taxes. It is commonly used from private equity perspective where it is a useful metric in establishing the debt capacity of the business, hence how much debt it can absorb.
Our preferred cashflow metric is free cashflow. The actual cash that can be distributed to shareholders. In most instances it includes reducing the operating cashflow by capital expenditure and other instances backing out a portion of depreciation and amortization charges.