Wednesday, February 9, 2011

Earnings per share, a simple way to measure if a company makes money.

Learn how to measure if a company makes money. Every income investor who follows my cash flow strategy knows that one of your first steps is to determine if the entity to whom you are lending money or in which you want to make an investment makes money. Moreover, if you invest for yourself, you need to be efficient at researching these companies. If you use an adviser, you need to decide if the company they recommend meets your criteria.

Where do you find this information? Financial information about these companies is available on many free finance websites and from your broker/dealer. You need to learn what data to collect to be an efficient investor. Most finance websites have an overview page where you can see a summary of the company including some information on how much money the company makes. Some of the data you will find include:

  • Sales 
  • Revenue
  • Income
  • Profit
  • Earnings
All of these numbers should be positive. No sales means no revenue; no revenue means no income etc. These are not as simple as they seem, however. You can have net income, gross profit, net profit. It can get very confusing. If you know how to read an income statement or a cash flow statement that is great, you have an edge on most ordinary investors. For the rest of you, I believe that earnings per share (EPS) is the easiest measure for the ordinary investor to use to determine if the company makes money.

You can calculate earnings by subtracting preferred stock dividends from net income. This leaves you with an idea as to how much money a company has to pay you a dividend. Earnings per share (EPS) is that number divided by the number of shares owned by all the owners. The number could be $.01 or $10.00 per share.

EPS is easy to find and easy to use to compare companies.

Income investors who keep it simple will benefit from time efficiency. Quickly determine if a company has EPS and know the value. Is it $1.00 per share or $0.10 per share or $10.00 per share? This is one of the first tests you apply to a potential investment. Eliminate all companies that do not have sales, all companies that do not have revenue and all companies that do not have earnings.

By using EPS, you save time and eliminate the bad companies right away. Investors invest in earnings. Only companies that make money have the option of paying out some money to you in income and for income investor's income is everything.

Very Truly Yours,