Earnings Per Share Ratio

There are many factors which are to be considered while making direct investment in the stock market. The past and present performance of the company, business model , future growth prospects for the company and cash position are some of these important factors. However, any business can survive and grow only if it is making a decent profit. The earnings per share ratio can help you to determine the profitability of the company which you wish to invest in. With the help of earnings per share ratio example, let us know how to calculate this ratio in the next paragraph.

How to Calculate EPS Ratio?

Here is the formula for calculating the price earnings per share ratio:

Earnings Per Share (EPS) = Net income - Dividends paid/Average outstanding shares

Thus, basic earnings per share ratio can be calculated by dividing the outstanding shares of the company at that time from the amount obtained by subtracting dividend on the stock from the net income of the company. Since the outstanding shares of the company can change, we should take the average number of shares over the reported term for our calculation. The more the earnings per share ratio, more would be the profitability of the company. The chances of getting high return on investment is maximum, if you invest in the stocks of a company having a high earnings per share ratio.

Let us discuss the concept of good earnings per share ratio with the help of a simple example. Let us assume that a company Y earned a net profit of USD 200 and has twenty shares outstanding. Also assume that a company Z also earned a net profit USD 200 and has fifty outstanding shares. Then, the earnings per share for company Y would be ten (200/20=10) and that for company Z would be four (200/50=4). So, investing your money in the company Y which has a more earnings per share, as compared to the company Z would be the right strategy. However, you should note that a knowledge of trailing EPS, current EPS and forward EPS is a must for succeeding in your investments. It is an accepted fact that earnings per share ratio can help us know the financial strength of a company. But, you should also be aware of what the P/E or price to earnings ratio of the company is. For calculating the P/E of a company stock, one needs to have the EPS of that company and also the current market price of the stock. In the next paragraph, we shall discuss a way of calculating P/E of a stock. More on stock investing.

How to Calculate P/E of a Company?

The P/E of a company is actually a ratio of the current market price of the stock in the stock market and the net profit earned by the company per share. Given below is the formula for P/E:

P/E = Market price of the Stock/Earnings per share (EPS)

If the P/E ratio of the company is high, then we can arrive at a conclusion that investors are paying a big price for that stock. This does imply that the stock has become expensive and somewhat risky. So, it would be advisable to invest in socks of companies with low P/E ratio. You can also compare the P/E of a particular company to the average P/E of all the companies in that particular sector, to decide whether you should buy stocks or not. In short, investing in stocks of companies which are trading at low P/E ratio and have strong fundamentals and balance sheet, along with good past history will be profitable.

For more articles on stock market, refer to:

• How do Stocks Work
• How to Play the Stock Market
• How does a Stock Market Crash

This was all about the earnings per share ratio and its importance while purchasing a stock. Another thing to remember while investing in capital markets is that a diversified investment portfolio can help us reduce losses in times of market crashes. So, all the best for your stock trading!