Investors can use hundreds of metrics to analyze stocks, but none are more widely known than earnings per share (EPS) and the price-to-earnings (P/E) ratio.
These can be highly effective tools for evaluating stocks. But they don't translate very well to companies that own a lot of real estate. Real estate investment trusts, or REITs, obviously fall into this category.
Here's a rundown of how you can use EPS and the P/E ratio to evaluate stocks, why they aren't very effective for REIT analysis, and an introduction to a better way to evaluate a REIT's "earnings."
Earnings per share and the P/E ratio
The traditional way to calculate earnings per share for publicly traded companies is to start with the company's net income. This is how much a company has earned after paying its operating expenses, interest obligations, and applicable corporate taxes.
Then, divide net income by the number of the company's outstanding shares of stock to calculate its earnings on a per-share basis. This is known as a company's earnings per share, or EPS.
For example, if a company earned an after-tax profit of $10 million and it has 5 million outstanding shares, its EPS would be $2.00 per share.
Many companies also calculate diluted earnings per share using things like unexercised options and warrants to determine how many outstanding shares there could potentially be.
You can calculate the price-to-earnings (P/E) ratio by taking a company's current stock price and dividing by its annual earnings per share. This can be very useful for comparing similar companies with each other to help determine which are the best-priced investments.
For example, if a stock trades for $45 and the company earned $3 per share over the past 12 months, its P/E ratio would be 15.
The P/E can theoretically be calculated based on any 12-month period. It's generally either done on a trailing 12-month (TTM) basis or a forward (next 12 months expected) basis. These are called the TTM P/E ratio and the forward P/E ratio, respectively.