EPS Earnings Per Share Welcome back again to MBAbullshit.com. The
topic for this video is EPS (Earnings per share) which is one of the Market value measures
or actually could also be a profitability measures depending on what book or which professor
you’re talking to or it could be both. Let’s just say it’s both.
Remember, you could always go back to MBAbullshit.com. This video discusses one of my free videos
on Liquidity, Profitability and Market value. Which include these ratios over here.
And after this, you can check out my next videos on MBAbullshit.com. Such as my video
on financial leverage ratios, and that video includes all of these ratios over here.
And you can also check on my other videos on MBAbullshit.com on turnover ratios. And
that video includes all of these ratios over here.
Let’s get down to it. Now let’s start with a story. Let’s say that ABC Company’s
Net income last year is one thousand dollars and there are one hundred shares outstanding.
What is its earnings per share? Well its super
simple, earnings per share is simply the total net income last year of the whole company
divided by the number of shares outstanding. Now, if you do this equation you’d find
that the earnings per share is exactly ten dollars, a nice simple easy round number.
Now this is the most easy part of financial ratio which is to compute the actual number.
What’s more important is what does this mean? This means that every share earns ten
dollars a year in profit, or last year every share earned ten dollars a year in profit.
Meaning, you get the whole profit of the company and you divide that by the total number of
shares. Then every shareholder, assuming every shareholder
owns exactly one share, then every shareholder
gets ten dollars a year in profit. Now I’d like to stress that this is ten dollars a
year in profit not in dividend. If you remember, you should know that by now
but if you don’t it’s okay. Remember that when a company earns profit it’s supposed
to share that profit or remit or give that profit back to the owners or back to the shareholders
in the form of dividends. Now, how much does the company pay back to
the owners in dividend? They could pay all of the profits to the owners in dividends,
or the company might keep some of the profits inside the company. And only use some of the
profits to give to the owners as dividends. In this case, when we compute the EPS or Earnings
per share, we talk about the profit per share or the earnings per share not the actual dividend
that the company eventually decides to pay to the shareholders.
Is a high earnings per share good or bad? Well generally, a low earnings per share is
bad because it means less earnings or money for the shareholders. A high earnings per
share is good because it means more earnings and money for shareholders.
Now, there is a major flaw with this ratio. Which is that the earnings per share is a
very incomplete indicator. It doesn’t take into account the price of the stock or the
owner’s investment. What do I mean by this? Let’s say you own
part of a company. Do you prefer an earnings per share of one hundred dollars or one dollar?
Of course, you would say one hundred dollars. But what if you had to pay one million dollars
for one share? And then it had an earnings per share of only one hundred dollars. Or
what if you paid only two dollars for a share of stock and then it had an earnings per share
of one dollar? As you can see here, you would prefer this
one instead of this. You invest only two dollars, then you get one dollar in earnings. But in
this first case, sure you get one hundred dollars in earnings but you had to pay one
million dollars for that share of stock. So it’s a much better deal to get this one
even if it has a lower earnings per share. Obviously we choose the second one.
How do we analyze it traditionally? First is to compare the historical earnings per
share of this company. Maybe it’s not your company, maybe you’re thinking about investing
in it. If the earnings per share is higher now than last year’s, then it indicates
that the company is more profitable than before. Now I stress, and if the earnings per share
is lower than last year’s, then it indicates that the company is less profitable than before.
There’s a very important thing to take note of. This only works if your company has not
had any stock splits, stock dividends, or share purchases or things like that. I do
have another video on stock splits and stock dividends, and share repurchases. I highly
recommend you watch that. Let’s just say, because it’s not so simple that’s a whole
video in itself explaining what happens to dividends when there are stock splits and
stock dividends. Because when there’s a stock split, your one share can suddenly become
two shares or there’s a share repurchases. The value of two shares might merge into just
one bigger value share and things like that. If you didn’t understand what I just said
please do watch my other video on dividend policy.
Anyway, the second way of analyzing this is to compare the earnings per share
of this company to other similar companies. Oops! But that’s actually not really a good
thing to do I think. And why because when you compare a ratio to other similar companies,
but that’s okay. But in this case, when you compare earnings per share to other similar
companies, this will only makes sense if the Market price per share is exactly the same
for similar companies or if the equity per share is exactly the same for similar companies.
But that never happens. The market price per share of walmart is never exactly the same
as the market price per share of target at the same time. Therefore, I would not really
recommend using this type of analysis for the earnings per share.
Instead of this it’s better to use the P/E ratio or the price earnings ratio instead.
And that one you can compare the different price earnings ratios of different companies.
Now you can watch my other free video on the price earnings ratio.
Alright, that’s it for now. I hope you learn something. Remember to share us if you like
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Have a great day and goodbye. debbierojonan Page 1