explain what earnings per share (EPS). How is EPS calculated and why it is important for...

explain what earnings per share (EPS). How is EPS calculated and why it is important for investors to gauge the value of a share?

Expert Solution

Earnings per share is the earning that the company is generating per share basis. Earning is an important component of a company. It shows how efficiently the assets of the company are used in order to generate earning. Earning per share gives an idea that per share wise, how much earning is the company generating. So if a shareholder is holding just one share, then how much earning is the company generating for the shareholder.

EPS is calculated = Net Income / Total Outstanding Shares

Say Net Income of a Company is $100M and Total Outstanding shares are 10M

So EPS = $100M / 10M

= $10

So Earning per share is $10.

EPS is very important for investors. Share price that is running in the market is based on future projected earning of the company. If it is estimated that future earning of a company will increase, then the share price increases.

One extremely important parameter that investor uses is Price/Earning Ratio.

Here Price is the share Price and Earning is the Earning Per Share. Say price of a Share is $20 and EPS of the share is $2.

So Price/Earning Ratio = $20 / $2

= 10 Times

So market is ready to pay 10 times the earning of the company for a stock, because they think that the earning will increase in future. Price/Earning ratio is used to compare companies in same sector to see whether the share price of a particular company is higher than peers. Then it means that the share price of the particular company can be overvalued.

jeff jeffy answered 2 years ago

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