EPS & PE

Earnings per share (EPS)

The earnings per share (EPS) is a widely-used ratio in stock value and securities analysis. It reflects the profits made per share.

The EPS of a company is calculated by dividing the `net income available for common stockholders' by the `total number of outstanding common stock shares'. The `net income available for common stockholders' is arrived at by deducting the dividends if any paid to the preferred stockholders of the business from the net income of the company.

However, this calculation does not account for any additional stock shares which the company may issue in future. For example, a business corporation may award its managers stock options to buy common stock shares of the company at fixed prices. If in the future the market value of the shares rises over the fixed option prices, the managers could exercise their rights and buy capital stock shares at a bargain price. This may dilute the EPS, as the net income will have to be spread over a larger number of stock shares.

To warn investors of the potential effects of stock options and convertible securities a second EPS is reported by public corporations, which is called diluted EPS

Price to earnings ratio (P/E)

The price to earnings ratio (P/E) is a widely quoted parameter of share value. The share price is divided by the EPS figure. For companies with the same EPS, a higher P/E for one company means its market price is higher, which in turn means that its expected future profitability is better. Comparing the P/E of a company with the industry average gives an indication of how a company is doing vis-à-vis the industry.