December 2, 2022
Business

How Are EPS and Stock Price Related?

Stock Price

Share trading online refers to selling and buying the shares of a company and other financial instruments on the stock market exchanges. But anyone who is intent on buying stocks of a company should be well acquainted with the terms “EPS” and “Stock Prices.”

These two terms together will give you an idea of how profitable it will be for you to invest money in the stocks of that particular company. It is important to understand that a high stock price does not necessarily mean that the company is going to provide a high Earnings Per Share (EPS) too. So, how are EPS and stock price related, let’s find out! 

What is EPS?

Earnings Per Share (EPS) is the measure of the profitability of the company, which is calculated on an annual basis by dividing the company’s profit by the total number of its outstanding shares.

It gives an idea to the investors about how reliable and profitable the company’s shares are and whether they should risk investing their money in the company or not. The higher the EPS, the greater the profit of the company is considered to be.

What is the Stock Price?

The price of stock refers to the value at which a single share of the company is available for trading on a stock exchange. It derives its basis from the company’s Initial Public Offerings (IPO) when the company gets listed in the stock market for the first time.

However, after listing the price of a stock is determined by the forces of its supply and demand in the market which is affected by a variety of factors such as the company’s performance, government policies, geopolitical sentiment, economic conditions, etc.

How are EPS and Stock Prices Related?

The relationship between EPS and the Stock Price depends on something called the EPS consensus, which is nothing but an expected EPS by the investors and traders in the market. If the actual EPS of a share meets or exceeds this consensus EPS, the price of a stock rises. Similarly, if the actual EPS fails to meet the expected EPS, then the stock price falls.

Since the consensus EPS is tricky to evaluate and might vary from one set of investors to others, you can make use of a ratio called the Price-Earnings (P/E) ratio to understand the relationship between these two metrics better.

P/E Ratio = Stock Price/Earnings Per Share

P/E ratio helps you understand the relative value of a stock and check whether the stock is undervalued, overvalued, or optimally valued. It basically tells you how much you need to invest in the stock to earn a 1 rupee of its earnings. For instance, if the P/E ratio of a stock is 30, it means, that in order to earn Rs. 1 of its earnings, you need to invest Rs. 30 in it.

Takeaway

Earnings per share is a financial metric of a company that serves as a measure of its profitability whereas the stock price is the market value of the company’s stock. Both are important aspects that must be taken into consideration before investing in the stock.