Even comparing the earnings of one company to another really
doesn’t make any sense, if you think about it. Earnings will
tell you nothing about how many shares the company has. Because you do
not know how many shares a company has, you do not know how many parts
that companies earnings have to be divided into. If the company has
more shares, the earnings will be divided into more parts.
For example, companies A and B both earn Rs.100, but company A has 10 shares outstanding, so each share holder has in effect earned Rs.10.
On the other hand, if company B has 50 shares outstanding and they too have earned Rs.100 then each shareholder has earned Rs.2. So you see it is important to know what is the total number of outstanding shares are as well as the earnings.
Thus it makes more sense to look at earnings per share (EPS), as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares.
EPS = Net Earnings / Outstanding Shares
So looking at the EPS ratio, you should go buy Company A with an EPS of 10, right? EPS is not the only basis of comparing two companies, but it is one of the methods used.
Note that there are three types of EPS numbers:
EPS doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some other ratios next....
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