To select the best stocks, investors must have tools that allow them to quickly compare companies of different sizes in different industries. For example, how does one compare the investment merits of Microsoft, a $200 billion dollar company with 8.6 billion shares outstanding, to a small software startup? Stock comparison tools can help.
Per Share Comparisons
To bring everything to the same denominator, investors compare things on a per-share basis. Earnings per share (EPS) is the foundation of many comparisons. EPS is determined by dividing a company’s net profits by the total number of outstanding shares.
Price-to-earnings ratio (P/E) is the current stock price divided by current annual EPS. It tells investors how much they are paying for $1 of earnings. The lower the ratio, the cheaper the stock.
Some investors call P/E ratios bottom line comparisons because they compare the bottom lines — the profits. Many also find the top line — sales — comparisons useful. Price-to-sales ratio is determined by dividing the annual sales by the total number of shares outstanding. Again, the lower the ratio, the cheaper the stock.
EPS Growth Rate
EPS growth rate is determined by comparing current year earnings to last year earnings and is expressed as a percentage. A 20 percent EPS growth rate means that the company has grown its earnings 20 percent in the past 12 months. The faster a company grows its earnings, the higher the stock price can go, so companies with the highest EPS growth are considered the best candidates for growth investing.
Which is better: stock A with a P/E of 30 and an EPS growth rate of 40 percent, or stock B with a P/E of 20 and an EPS growth rate of 15 percent? The lower the P/E, the cheaper the stock, so B would be better. But the higher the EPS growth rate, the better, so A would be better.
To compare apples to apples, some investors use P/E to EPS growth rate — PEG. The lower the number, the cheaper the stock, and the more upside potential it presumably has. Stock A has a PEG of 0.75 (30 ÷ 40), while stock B has a PEG of 1.22 (20 ÷ 15), so A is a better investment candidate.