Would it be valid to assume that a stock with a low P/E ratio and also very high EPS is, generally speaking, a better purchase than a stock with that same P/E but lower EPS?
My reasoning for this is that if EPS is the denominator in the P/E ratio, then a higher denominator means potential future price increases will have less of an upward effect on the P/E than if the denominator was lower. That could mean the stock has more potential upside before it starts to look overvalued, which factors into overall demand.
Of course there are tons of other factors to consider -- but all other things being equal if you have two stocks, both with a P/E of 2, and one has an EPS of 5 whereas the other has an EPS of 10 is the latter a better purchase?
The flipside of this logic that I am wondering about is earnings growth potential. Obviously if EPS is expected to decrease or increase that has important implications. Is it possible that a stock with a high PE and relatively low EPS is a really good purchase if EPS growth is expected? I think I read a rationale along these lines in Burton Malkiel's book but I'm not positive -- since PE is a price-to-earnings multiple, you could look at it this way:
If a stock has a P/E of 8 and EPS is expected to increase $1, then price should actually increase by $8 assuming constant P/E. A similarly priced stock with a lower P/E of only 4 would only increase $4 with the same earnings increase. This is sort of a counter-intuitive attitude towards P/E since a higher P/E could actually be beneficial.
Is it valid to look at valuation ratios this way? The tricky part is that you have to assume certain values remain constant, I suppose.