The Earnings Per Share (EPS) & Price-to-Earnings Ratio (P/E Ratio): Definitions. Formulas. Examples.
If you are interested in investing in stocks, you may have come across the terms earnings per share (EPS) and price-to-earnings ratio (P/E ratio). These are two important metrics that can help you evaluate a company’s profitability and valuation. In this blog post, we will explain what they are, how to calculate them, and how to use them in your investment decisions.
What is Earnings Per Share (EPS)?
Earnings per share (EPS) is the amount of a company’s profit allocated to each outstanding share of a company’s common stock. It is a measure of how much money a company makes for its shareholders. EPS is calculated by dividing the net income by the number of outstanding shares. The formula is:
For example, if a company has a net income of $10 million and 100 million outstanding shares, its EPS is:
This means that the company earned $0.1 per share.
What is Price-to-Earnings Ratio (P/E Ratio)?
Price-to-earnings ratio (P/E ratio) is the ratio of a company’s current share price to its earnings per share. It is a measure of how much investors are willing to pay for a company’s earnings. A high P/E ratio could mean that a company’s stock is overvalued, or that investors are expecting high growth rates in the future. A low P/E ratio could mean that a company’s stock is undervalued, or that investors are pessimistic about its prospects. P/E ratio is calculated by dividing the current share price by the earnings per share. The formula is:
For example, if a company’s current share price is $20 and its EPS is $0.1, its P/E ratio is:
This means that investors are paying $200 for every $1 of earnings.
How to Use EPS and P/E Ratio in Investing?
EPS and P/E ratio are useful tools for comparing different companies in the same industry or sector, or for comparing a company against its own historical performance or the market average. However, they are not the only factors to consider when investing in stocks. Here are some tips on how to use them effectively:
- Compare EPS and P/E ratio with similar companies: A company’s EPS and P/E ratio may vary depending on its size, growth stage, business model, and industry. Therefore, it is more meaningful to compare them with other companies that have similar characteristics, rather than with the overall market or a different sector. For example, a technology company may have a higher P/E ratio than a utility company, because investors expect faster growth and higher returns from the former. Similarly, a mature company may have a lower P/E ratio than a young company, because the former has more stable and predictable earnings, while the latter has more potential for growth and innovation.
- Consider the growth rate of EPS: A company’s EPS may change over time, depending on its earnings performance and the number of outstanding shares. A company that can consistently increase its EPS may indicate that it is profitable, efficient, and competitive. A company that has a declining or negative EPS may indicate that it is losing money, facing challenges, or diluting its shareholders. Therefore, it is important to look at the growth rate of EPS, rather than just the absolute value. A common way to do this is to use the PEG ratio, which is the P/E ratio divided by the EPS growth rate. A lower PEG ratio may suggest that a stock is undervalued relative to its earnings growth potential, while a higher PEG ratio may suggest that a stock is overvalued relative to its earnings growth potential.
- Be aware of the limitations of EPS and P/E ratio: EPS and P/E ratio are not perfect indicators of a company’s value or performance. They may be affected by accounting methods, non-recurring items, share buybacks, dividends, and other factors that may not reflect the true economic reality of a company. Therefore, they should be used with caution and in conjunction with other financial ratios and metrics, such as revenue, cash flow, debt, margins, return on equity, and so on. Additionally, EPS and P/E ratio are based on past or estimated earnings, which may not be accurate or reliable, especially for companies that have volatile or cyclical earnings, or that operate in uncertain or changing environments. Therefore, they should be used with a margin of safety and a long-term perspective, rather than as a basis for short-term speculation or trading.
Examples of EPS and P/E Ratio
To illustrate how EPS and P/E ratio can be used in investing, let us look at some examples of real companies and their financial data as of December 28, 2023 (source: Yahoo Finance).
- Apple Inc. (AAPL): Apple is one of the world’s largest and most successful technology companies, known for its innovative products and services, such as the iPhone, iPad, Mac, Apple Watch, AirPods, Apple TV, Apple Music, iCloud, and App Store. Its EPS for the trailing 12 months (TTM) is $6.32, and its EPS for the current fiscal year (FY) is estimated to be $7.02. Its current share price is $182.77, and its P/E ratio based on TTM EPS is 28.92, and based on FY EPS is 26.04. Its EPS growth rate for the next five years is estimated to be 11.9%, and its PEG ratio based on this growth rate is 2.43. Compared to its industry average P/E ratio of 34.64, Apple’s P/E ratio seems relatively low, which may indicate that it is undervalued or that it has a competitive advantage over its peers. However, compared to its own historical P/E ratio range of 10.09 to 46.86, Apple’s P/E ratio seems relatively high, which may indicate that it is overvalued or that investors have high expectations for its future growth. Therefore, Apple’s EPS and P/E ratio suggest that it is a profitable and growing company, but also a popular and expensive one.
- Walmart Inc. (WMT): Walmart is one of the world’s largest and most diversified retailers, operating thousands of stores and e-commerce platforms across various segments, such as grocery, general merchandise, health and wellness, and membership clubs. Its EPS for the TTM is $5.48, and its EPS for the current FY is estimated to be $6.18. Its current share price is $144.18, and its P/E ratio based on TTM EPS is 26.31, and based on FY EPS is 23.33. Its EPS growth rate for the next five years is estimated to be 5.6%, and its PEG ratio based on this growth rate is 4.7. Compared to its industry average P/E ratio of 24.01, Walmart’s P/E ratio seems slightly high, which may indicate that it is overvalued or that it has a strong brand and market position. However, compared to its own historical P/E ratio range of 14.42 to 69.91, Walmart’s P/E ratio seems moderate, which may indicate that it is fairly valued or that it has a stable and consistent earnings performance. Therefore, Walmart’s EPS and P/E ratio suggest that it is a profitable and mature company, but also a slow-growing and pricey one.
- Tesla Inc. (TSLA): Tesla is one of the world’s leading and most innovative electric vehicle and clean energy companies, producing and selling various models of cars, batteries, solar panels, and software. Its EPS for the TTM is $1.99, and its EPS for the current FY is estimated to be $4.63. Its current share price is $1,066.90, and its P/E ratio based on TTM EPS is 536.13, and based on FY EPS is 230.47. Its EPS growth rate for the next five years is estimated to be 50%, and its PEG ratio based on this growth rate is 10.72. Compared to its industry average P/E ratio of 19.87, Tesla’s P/E ratio seems extremely high, which may indicate that it is overvalued or that it has a unique and disruptive business model. However, compared to its own historical P/E ratio range of -1,023.08 to 1,336.27, Tesla’s P/E ratio seems within its normal range, which may indicate that it is fairly valued or that it has a volatile and unpredictable earnings history. Therefore, Tesla’s EPS and P/E ratio suggest that it is a profitable and fast-growing company, but also a risky and expensive one.
Conclusion
EPS and P/E ratio are two important metrics that can help you evaluate a company’s profitability and valuation. However, they are not the only factors to consider when investing in stocks. You should also look at other financial ratios and metrics, as well as the company’s business strategy, competitive advantage, growth potential, and risks. Additionally, you should compare EPS and P/E ratio with similar
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