EPS Vs PE Ratio- Know the Difference

Investors who evaluate a company's financial health and investment potential come across two parameters: EPS (Earnings Per Share) and PE (Price-to-Earnings). Both these parameters are related to a company's earnings but provide different perspectives to investors and are used for distinct purposes. Let us look at these two parameters in detail and look at the differences for better understanding.

What is EPS?

Earnings Per Share (EPS) is a metric that measures the portion of a company's profit allocated to each outstanding share of its common stock. It indicates a company's profitability on a per-share basis and is widely used by investors to evaluate the financial performance and the company's profitability. You can calculate EPS using the below formula:

EPS = (Net Profit - Preferred Dividends)/(Weighted Average Number of Outstanding Shares)

Here,

• Net Profit: Total company's earnings after all expenses, taxes, and interest.
• Preferred Dividends: Dividends paid to preferred shareholders. These are deducted because EPS focuses on common shareholders.
• Weighted Average Number of Outstanding Shares: The average number of shares outstanding during a reporting period.

You will come across two types of EPS:

• Basic EPS: Calculated using the total net income and the weighted average number of shares.
• Diluted EPS: Adjusted for potential dilution from securities like stock options, warrants, or convertible bonds.

​Let us understand EPS with an example. Assume Company A has the following financial details for the year:

• Net Profit: Rs 1,000 crore
• Preferred Dividends: Rs 100 crore
• Weighted Average Outstanding Shares: 100 crore shares

Using the above formula, EPS comes out to be (1000 - 100) / 100 = Rs 9

What is the PE Ratio?

Price-to-Earnings Ratio is a metric used to evaluate the valuation of a company's stock. It shows the relationship between the company's stock price and Earnings Per Share (EPS). Essentially, it tells you how much investors are willing to pay for Rs 1 of the company's earnings. Now that you understand EPS and know how to calculate it, PE calculation is simple :

PE = Market Price per Share / Earnings Per Share (EPS)

Here,

• Market Price per Share: The current price of one company's share.
• Earnings Per Share (EPS): The profit allocated to each outstanding share of common stock

In the previous example, let us assume that company A's share price is Rs 360. We calculated the EPS as Rs 9. Using the above formula,

PE = 360 / 9 = 40.

So, PE is 40, which means investors are willing to pay Rs 40 for every Rs 1 of earnings the company generates.

We can use PE to compare companies from the same sectors. Let us take the example of another company - B. The share price of company B is Rs 200, and EPS is Rs 10. So, the PE of company B is 20.

• A higher P/E ratio indicates that investors expect higher growth in the future, or the stock may be overvalued.
• A lower P/E ratio could mean the stock is undervalued or that the company has lower growth prospects.

Additional Read: Understanding P/E Ratio

Difference between EPS and PE

Below are the key differences between the two parameters:

Limitations of EPS and P/E:

• EPS can be manipulated: Companies can sometimes use accounting techniques to artificially inflate earnings.  
• P/E can be misleading: Comparing P/E ratios across different industries can be misleading due to varying growth rates and risk profiles.  
• Both metrics are backward-looking: They are based on past performance and don't guarantee future success.

Before you go

EPS and the P/E ratio are valuable tools for investors, providing insights into a company's profitability and valuation. However, they should not be used in isolation. By understanding the nuances of these metrics and using them in conjunction with other financial analysis techniques, investors can make more informed and effective investment decisions.