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.
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Have a great day and goodbye.
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