EPS, P/E and market cap
How to tell whether a stock is 'expensive', and why a high price doesn't mean big.
Market cap: the size of the company
Market capitalisation (market cap) is the total value of all a company's shares: share price times number of shares. It tells you how big the market thinks the company is.
The share price alone tells you almost nothing about size. A $500 stock can belong to a smaller company than a $50 stock, if the $50 company has many more shares.
EPS: profit per share
Earnings per share (EPS) is net income divided by the number of shares. If a company earns $1 billion and has 500 million shares, its EPS is $2. It lets you compare profit growth over time even as the number of shares changes.
P/E: the price tag on profits
The price-to-earnings ratio (P/E) is the share price divided by EPS. A stock at $40 with EPS of $2 has a P/E of 20: investors are paying $20 for every $1 of yearly profit. Trailing P/E uses the past year's earnings; forward P/E uses forecasts.
A high P/E usually means investors expect strong growth. A low P/E can mean a bargain, or that investors expect trouble. P/E doesn't work for companies with no profits, and it varies by industry and over time. It's a starting question, not an answer.
Company A: share price $200, 100 million shares, net income $1 billion. Market cap = $200 x 100 million = $20 billion. EPS = $1 billion / 100 million = $10. P/E = $200 / $10 = 20.
Company B: share price $50, 1 billion shares, net income $1 billion. Market cap = $50 billion. EPS = $1. P/E = 50.
B has the lower share price but is the bigger company, and investors pay much more for each dollar of its profit, likely because they expect faster growth.
Key terms
- Market cap
- Share price times number of shares: the market's total value for a company.
- EPS
- Earnings per share: net income divided by the number of shares.
- P/E ratio
- Share price divided by earnings per share: how much investors pay for $1 of yearly profit.
Market cap shows size, EPS shows profit per share, and P/E shows how much investors are paying for those profits.