2017-05-18 / The Motley Fool

Ask the Fool

Bigger Isn’t (Necessarily) Better

Q: When investing, should I look for or favor companies with high earnings per share (EPS)?

— G. M., Fort Myers, Florida

A: In isolation, a company’s EPS doesn’t mean much — except that, if it’s positive, the company has earnings rather than losses.

Imagine that Excelsior Hair Growth (ticker: SPROUT) has total net income of $50 million this year. If it has 50 million shares of stock outstanding, then its EPS is $1. ($50 million divided by 50 million is $1.) If it issues more stock, though, and suddenly has 60 million shares outstanding, its EPS will be lower, at $0.83. ($50 million divided by 60 million is $0.83.)

Now imagine two equally wonderful companies with identical net income. If one has half as many shares as the other, its EPS will be twice as big. That doesn’t mean that it’s a better or worse company. There’s no perfect number of shares for a company to have, either. Some have millions, and some have billions.

It’s more important to check whether the EPS has been rising over time. Examine many other numbers, too, to get a fuller picture. After all, a company’s earnings can be manipulated legally via various accounting maneuvers.

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Q: I’m a small investor. How much should I invest when it costs me $7 per trade?

— T. C., Warren, Ohio

A: Aim to spend no more than 2 percent of your investment on commission costs. So if you’re spending $7 on a trade, you should be investing at least $350. Some years ago, commissions could be $25 or much more. A $25 commission would require aiming for an investment of $1,250.

Remember to diversify, too, spreading your money across a handful of stocks — or opt for a broad-market index fund. ¦

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