How To Understand And Interpret EPS When Analyzing Shares?

Investment

oi-Sunil

By Sunil Fernandes

Updated: Friday, April 1, 2016, 14:32 [IST]

Earnings per share or EPS, is one of the most important financial indicators that an analyst uses when he or she analyzes shares and stocks.

Of course, EPS is never studied in isolation, and is always studied along with the price to earnings ratio or p/e.

Let us first begin by understanding what EPS is.

Let us say a company has an equity capital of Rs 10 lakhs, comprising of 1 lakh shares of Rs 10 each. We say that the number of equity shares outstanding is 1 lakh. If the company makes a net profit of Rs 10 lakhs, than the EPS would be= 10 (net profits)/1 (equity share capital) = Rs 10.

So, the EPS would be Rs 10.

What EPS has got to do with stock price?

A question often arises on what the EPS has got to with the stock price. It has a lot to do, for fundamental analysis. Say for example, if the stock price is Rs 100 and the EPS is Rs 10, than we say that the p/e is 10.

Say, you are examining two banking stocks to buy. One has a p/e of 8 and the other has a p/e of 16, you would prefer the one with a p/e of 8, because it is cheaper.

However, it does not mean that if the p/e is lower at is always cheap and better. There are various other parameters that apply including price to book value, dividend yield, quality of management etc.

For example, there are some stocks that are horribly expensive in terms of p/e like Hindustan Unilever, which has a p/e of 40. Analysts are ready to offer a higher p/e and hence a higher share price for HUL, because of a number of reasons.

These include its MNC status. Apart from this iconic brands like Lux, Close Up, Fair and Lovely, Surf, Pepsodent, Brooke Bond, Dove, Taj Mahal, Lifebuoy, Sunsilk, Vaseline etc.

So, eps, p/e etc, should never be looked in isolation. It should always be studied with various other parameters like p/e, book value, quality of management of a company, industry that a company operates, growth prospects etc.

To cite en example would be HDFC Bank. The bank has amongst the highest p/e ratio compared to other banks like ICICI Bank. This is because it has the best asset quality in the business and consistently chalks out growth of 20-25 per cent every quarter. So, never look at EPS, p/e etc., in isolation. Do a careful study of other things as well.

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