Before investing in stock market, understanding fundamental analysis of a stock is imperative. Suppose an investor is in a dilemma of picking a stock A or B from the same sector then EPS (earning per share) and PE (price to earnings) ratio are the two tools which would be helpful.
Understanding Earning Per Share, Price To Earnings ratio
As a value investor it is important to know the health of the company before investing. Every company announces its results quarterly. Basic Earnings per share is obtained by dividing total earnings of the company with the outstanding number of shares. For example, if we consider Havells stock
Net income for the last quarter was Rs 22,225 (in crores) and outstanding number of shares is 625. When we divide Rs 22,225/625 we get 35.56. This is the earning per share.
To understand the profitability of vesting in a particular company, EPS is used as a tool. Another way of calculating EPS is known as diluted Earnings per share. It is,
(Net income after taxes – dividends) / No. of shares
Another tool which helps the investor while picking up a stock is PE (Price to earnings) ratio. It is obtained by dividing market value per share with earnings per share. For example, Havells current market price is Rs 650 and when it is divided by EPS which is approximately 35 we get 18.5. If the P/E ratio is 30 then it is an over-valued stock. If the fundamentals of the stock is good then even if PE ratio is 30 then one can still invest.
On an average PE ratio of various sectors is like this
companies = 20
Textile companies = 8
companies = 25
Banks = 29
Hence, PE ratio differs for each company. To conclude, it is better to invest in a stock whose PE is undervalued though an overvalued PE nevertheless may yield good returns if its fundamentals are strong.
(The author is ahomemaker who dabbles in stock market investments in free time)