Thorough stock research involves a close scrutiny of a company's balance sheets. The inherent worth of a stock needs to be determined through an analysis of the stock's past performance, the business potential of the company, and its future prospects. You need not rely on speculation to buy them.
A sound intellectual structure, that can ascertain the intrinsic value of a stock is needed. One way of ascertaining the performance value of a stock, is by knowing the Earnings Per Share (EPS) ratio.
Suppose, you have narrowed down to one industry sector, from which, you would like to pick stocks. There may be more than one well-performing stocks in there and it can be highly confusing if you rely on speculation, to choose one stock. To clear the confusion, analyze the company balance sheets, with respect to past performance.
When you make a stock investment, you buy partial ownership in a company. A company issues two types, which includes common and preferred stock. Earnings per share are calculated with respect to common stock.
Stocks that are currently in possession of stock market investors are known as outstanding shares. To put it in simple words, it is the quantum of profit that a company makes for every outstanding share, that it has issued.
More precisely, EPS is the net income of any company, after it has been adjusted for paid dividends, for every one of its outstanding shares. Since their number is a dynamic quantity, while calculating the ratio, for a year, you may have to average out the number of outstanding shares. Here's the formula:
Earnings Per Share = (Company's Net Income - Stock Dividends Paid) / Weighted Average Number of Outstanding Shares
Once you understand this formula, used for stock research, half the battle is won. All that remains is to substitute the values of net income, stock dividend value, and weighted average number of outstanding shares, to get the ratio calculated.
So, it is essential that you garner all these details from a company's financial statements for previous years. The value you calculate on the basis of past net income, will be known as the trailing EPS value.
A calculation example will make it easier for you to understand the method. Consider a company which has had a net income of USD 20,000,000 in one financial year. It must pay USD 2,000,000 in dividends and the number of its outstanding shares is 6,000,000. So what will be the EPS value for this company? Let us see.
Earnings Per Share = (USD 20,000,000 - USD 2,000,000 ) / 6,000,000 = USD 3
Thus the EPS value would be USD 3. To calculate diluted earnings value, formula is the same, but you will need an estimate of the number of new outstanding shares that could be introduced from convertibles like stock options and debentures.
Do not rely on the EPS value as the only parameter that influences your decision. Calculate the Price/Earnings ratio and study the liquidity, as well as debt-to-income ratio of the company and then decide whether buying it would be a worthy investment.