How to Select the Best Company with EPS Information?

Actual Question:

Companies A,B, C with Share Price 40 each and EPS is 2,4,10 respectively which one is better to invest and Why? Considering EPS is the only Factor.

Answer:

Dear Friend!

Thank you for the nice question.

Earnings Per Share (EPS) is one of the key parameter on which companies can be evaluated both individually as well as relatively.

However absolute figures of EPS are not readily comparable when the share prices are different. Luckily in your question you have kept the prices constant. Therefore, from the earnings per share and the market price we should draw a ver crucial as well as readily comparable information called the ‘Price to Earnings (PE) Ratio’.

The PE Ratio is obtained by dividing the current market price (CMP) by EPS. The PE Ratio as per standard value investing practices shall be any positive number that is below 15. Lower this number better it is. It should not be negative as only a negative EPS can yield a negative PE Ratio and a negative EPS menas the company has suffered a loss.

Now lets calculate the PE Ratios of all the three companies.

It is evident from the above table that company C has the lowest positive PE ratio and therefore is the best. The PE Ratio of company B is below 15 and standing at 10 which is perfectly alright. Company A with a score of 20 (over 15) is the worst and therefore shall be rejected.

Incidentally the PE ratio also indicates in how many years the company earns back our investment. Therefore the lowest number is the best. Company C earns back the investment in four years (an ROI of 25%) which is wonderful.

One year EPS and PE Ratio can be by fluke and therefore misleading. therefore the PE Ratio computed from the average EPS of the last five years or the latest year, whichever is lower shall be considered.

Please note that besides the price to earnings ratio, for a thorough evaluation of a company, there are many more parameters that need to be considered. Following are some of the parameters:

1. Price to Book Value
2. Dividend Yield
3. No or low indebtedness
4. Distance from 52 week high
5. Last five year share price returns

In conclusion best company can be selected from the EPS  and price information by computing the price to earnings ratio. Many other techniques also shall be employed complementary to the PE Ratio.

Thank you,

With Best Regards,

Anand

Types of Mutual Funds

Mutual funds can be categorised based on a few aspects as follows:

1. Nature of underlying assets: Equity/ Debt funds
2. End use of income: Growth/ Regular Income
3. Type of fund management: Active/ Passive
4. Liquidity: Liquid funds
5. Exchange Traded Funds

Equity versus Debt funds:

This aspect is based on what type of assets into which the money is invested. There are three possible sub-categories:

• Invest funds 100% in equity shares of companies
• Invest funds 100% funds in debt instruments like government bonds, treasury bills, corporate bonds, etc.
• Hybrid funds where money is partly invested in shares and partly in debt instruments

Growth versus Regular Income Funds:

In a growth fund, the income like dividend received from the underlying assets are reinvested. Growth funds are usually equity based.

On the contrary in a regular income fund the income earned by the fund by way interest, dividend, etc is distributed to the unit holders.

One obnoxious practice many mutual funds engage in is that they distribute sale proceeds of investment assets (capital receipts and not income receipts) as dividends to unit holders.

Active vs Passively Managed Funds:

Mutual fund managers constantly churn portfolios with an intended objective of beating the performance of certain benchmark indices like S&P 500, BSE Sensex, etc. Such funds are called actively managed funds. The funds charge high fund management fees (3–4%) as a justification for actively managing the funds. This is does not benefit the mutual fund investors.

On the contrary, passively managed funds reflect a popular index like S&P 500 and BSE Sensex. In this case the fund manager simply makes an one-time investment in the exact proportion corresponding to the composition of the index, and simply sits quiet. Any changes will be made only when there is a change in the composition of the index. Since the fund is not actively managed the fund management fee is very low (usually below 0.50%). The passive funds are beneficial for the investors as the actively managed funds have any established track record of superior performance over a long period of time.

Liquid Funds:

Liquid funds are meant for companies and corporations which tend to hold huge funds for temporary periods. They would like to invest these funds and earn returns for short periods of time. Such funds are called liquid funds. These funds offer only limited returns and almost negligible growth (capital appreciation). Liquid funds are not meant for common investors who are on the way of building wealth. 

Exchange Traded Funds:

Exchange traded funds (ETFs) are a totally unique concept of a mutual fund. It is doubtful whether an ETF can be discussed in the same breath with a mutual fund at all.

The units of an ETF are listed on the stock exchanges and trade shoulder-to-shoulder with shares. Thus ETFs provide following unique features to an otherwise normal mutual mutual fund:

1. Convenience - unlike subscription to mutual funds, there is absolutely no paper work involve. One can simply buy and sell them on the stock trading platform.
2. No special redemption process: If an investor wants to liquidate the investment with a regular mutual fund he or she has to submit an application to the mutual fund for redemption. This may take some time. However in the case of ETFs the investor simply sells on the on-line trading platform and the proceeds.
3. Exchange Traded Funds mostly track popular indices like the S&P 500 and BSE Sensex, NIFTY 50 and so on and therefore are passively managed with consequent low fund management fees.

Suggested Related/ Further Reading:

• What Is The Difference Between Dividend and Growth Fund. Which Is Better?
• What is an Exchange Traded Fund?
• How Frequent Changes to Mutual Fund Portfolio Affect Investor Interest?
• How to Choose the Right Mutual Fund to Invest?

In conclusion there are many types of mutual funds based on the assets managed, whether income is accumulated or distributed, whether actively or passively managed, etc.