Why is earnings per share important to investors?

Why is earnings per share important to investors?

Earnings per share (EPS) is a good way of indicating a company’s profitability to investors. Higher EPS typically means a company is more profitable than a company with lower EPS. However, investors need to look at the complete financial profile of a company to determine if the investment is worth it.

Imagine, being able to easily identify if a company is profitable. You have a better inclination of if a company is worth your money.

Earnings per share is only one factor, but it is an important thing to look at.

Luckily for you, I’ll show you what EPS is and what a good earnings per share is. I’ll even show you certain traps new investors fall for when investing. You’ll have a better understanding of how to use EPS at the end of the article.

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What is earnings per share (EPS)?

Earnings per share is a company’s net earnings on a per share basis. Higher earnings per share is an indication that the company is profitable in comparison to low earnings per share. Earnings per share is used as one of many indicators when evaluating a stock.

For example, Company A has an EPS of $25 and Company B has an EPS of $17. You would immediately think that Company A earned more money than Company B.

However, Company A might have 3 million shares and Company B 10 million. Therefore, Company A had a total earnings of $75 million and Company B had total earnings of $170 million. Company B simply had more shares which means less profit per investor share.

Consider earnings per share as a simple screen to see if a company is profitable. Keep in mind, taking on large amounts of debt, selling assets, or other financial moves could skew a company’s EPS.

What is a good earnings per share?

High earnings per share are typically a good indication the company is profitable. However, earnings per share of one company should be compared to others in the same industry to determine what is good. Earnings per share growth can also be more beneficial than looking at just EPS.

Is EPS more important than revenue?

Earnings per share is typically considered more important than revenue. Earnings per share is a good indication of how profitable a company is on a per share basis. Companies can grow in revenue while offering more shares to investors or diluting the shares.

Let’s take a look at a hypothetical company:

Year Net Revenue Earnings Per Share Number of shares
2020 5 million $5 1 million
2021 6 million $3.33 1.8 million
2022 8 million $2.67 3 million

As you can see, net revenue is increasing, which looks great! However, the earnings per share is decreasing year over year because the company keeps adding more equity through share offerings. As an investor, you are earning less for your ownership in the company year over year.

Is EPS a good indicator?

Earnings per share is only one of many good indicators to consider when evaluating a company’s stock. Look for companies with positive earnings per share and consistent earnings per share growth. Consider other factors, such as price to earnings or price to book ratio before buying a stock.

Earnings per share growth is considered a good indicator. A good sign is finding a company who’s EPS grows consistently year over year or quarter over quarter. Continual EPS growth shows a company’s product or service is in demand and continuing to grow. 

You’ll also want to consider other indicators which give insight to a company’s finances. 

For example, both Company A and Company B have an earnings per share of $10. However, Company A has a price to earnings of 35, meaning the company may be over valued. In other words, the company is trading at 35 times their earnings.

Company B has a price to earnings of 5 or trading at 5 times their earnings. This company may be undervalued.

Why is earnings per share important to investors?

Earnings per share is important to investors because it communicates the profitability of a company to investors. Earnings can influence share prices and profitability for investors. Investors can use EPS to help determine if investing in a company is a good move for their portfolio.

Do investors get earnings per share?

Investors do not directly get earnings per share because EPS is the profitability of a company per share. However, investors may receive a dividend payment if the company offers one. 

Dividend investors should be aware of a company’s dividend payment and earnings per share. You may want to avoid investing in a company who is paying more in dividends than they are earning. 

For example, a company may offer a quarterly dividend of $0.84 with an earnings per share of $3. Therefore, in one year you would receive $3.36 for every share you own in dividends. The company earned $3 per share and paid you $3.36 per share, meaning $0.36 per share needs to come from somewhere.

In this case, the company is losing money because they are paying out more than they’re earning. Investors should be aware that this could lead to dividend cuts.

Summary: What EPS means to investors

As you can see, EPS is a simple way of communicating a company’s profitability to investors. Investors use this information to determine if a company is worth investing in. Typically, higher earnings per share indicates a higher earning company.

Keep in mind, EPS is only one tool investors have for evaluating a company. Other indicators should be used, such as price to earnings ratio. Revenue is not always the best means of determining how profitable a company is for investors, so EPS is preferred.