I am new to shares and the stock market, and I was just wondering, when considering which companies to buy into, why should I consider the EPS as a factor of whether or not I should buy in?
- EPS is a starting point- at least there's an "E" !
- Some very fast growing companies are investing all their revenue and have little to no "E" at all. Doesn't mean it's a bad investment IF (!) they eventually produce earnings- you need to know the industry characteristics. Think bio-tech companies looking for a cancer cure- it's very costly to develop the drug, and there will be losses for years even though the revenue is growing very quickly.
- Comparing EPS with other companies in the same industry won't tell you much (it depends on the number of shares, for example), but how your company EPS changes over time compared with others in the same industry is an OK yardstick.
Earnings per share is the company profit (or loss), divided by the number of outstanding shares.
The number should always be compared to the share price, so for instance if the EPS is $1 and the share price is $10, the EPS is 10% of the share price. This means that if the company keeps up this earning you should expect to make 10% yearly on your investment, long term. The stock price may fluctuate, but if the company keeps on making money you will eventually do so too as investor.
If the EPS is low it means that the market expects the earnings to rise in the future, either because the company has a low profit margin that can be vastly improved, or because the business is expected to grow. Especially the last case may be a risky investment as you will lose money if the company doesn't grow fast enough, even if it does make a healthy profit.
Note that the listed EPS, like most key figures, is based on the last financial statement. Recent developments could mean that better or worse is generally expected.
Also note that the earnings of some companies will fluctuate wildly, for instance companies that produce movies or video games will tend to have a huge income for a quarter or two following a new release, but may be in the negative in some periods. This is fine as long as they turn a profit long term, but you will have to look at data for a longer period in order to determine this.