So, let’s start a series of articles on what to look for when analyzing a company’s stock. I will try to explain everything very simply and with examples. I will say right away that in no case do I pretend to be the ultimate truth and I will operate not with complex economic models, but with a simplified (“dirty”) version of market analysis.
The advantage of this approach is that you can quickly (in about a couple of hours) analyze the situation with the company’s shares and draw a conclusion about the expediency or, on the contrary, the inexpediency of their acquisition. The disadvantages of this approach are a rather superficial assessment, but, in my opinion, quite often such an assessment is quite enough. Go…
Selecting shares of company A and B
Imagine we have Company A and Company B. VERY IMPORTANT! Companies operate in the same industry. Let’s say it’s retail.
Company A has 1,000 shares and Company B has 1,500 shares. The prices for the shares of both companies are the same. Over the past reporting period, company A earned 1.5 million rubles of net profit, and company B earned 2 million rubles. Question: Which company’s shares are more attractive for investment?
Actually, correct answer: I do not know, because the incoming information is clearly not enough to make the right investment decision. However, focusing only on the available information, the following conclusion can be drawn: the shares of company A are more interesting.
The reason is that it is not entirely correct to compare companies based on earnings alone. It is important to understand the following: the main goal of the management of any public company is to increase the welfare of its shareholders, or, more simply, to increase the company’s capitalization. If we imagine that both companies have the number of shareholders equal to the number of outstanding shares (i.e., company A has 1,000 people owning one share, and company B has 1,500 such shareholders), then it turns out that the shareholders of company A are in a more advantageous position, since each of their shares accounts for 1,500 rubles. net profit of the company (1.5 million divided by 1000). Company B, although it has earned more, is forced to divide this pie into a much larger number of parts – each shareholder will have 1,333.3 rubles. net profit.
Earnings per share (EPS) – a fairly simple and effective indicator measured in currency. It is calculated as the ratio of net profit to the number of company shares. Allows you to compare several competing companies, evaluating the effectiveness of investments in certain shares. All other things being equal, you should choose the stock of the company with the highest EPS.
Ideally, EPS should grow all the time. This can be achieved in two ways: by increasing the net profit (the company is working more efficiently), or by reducing the number of shares (buyback). EPS is used to calculate one of the most popular P / E multiples on the market. But more on that next time.
In the meantime, let’s look at the EPS picture of Russian companies with a market capitalization of over 1 trillion rubles.