EPS vs. FCF

Attribute	EPS	FCF
Definition	Earnings per share is a company's profit divided by the number of outstanding shares.	Free cash flow is the cash generated by a company's operations after accounting for capital expenditures.
Calculation	Net income / Average outstanding shares	Cash flow from operations - Capital expenditures
Importance	EPS is important for investors to assess a company's profitability and growth potential.	FCF is important for investors to evaluate a company's ability to generate cash and reinvest in the business.
Volatility	EPS can be volatile due to accounting rules and one-time charges.	FCF can be more stable as it focuses on cash flow rather than accounting profits.

Introduction

Earnings per share (EPS) and free cash flow (FCF) are two important financial metrics that are used by investors to evaluate the financial health and performance of a company. While both metrics provide valuable insights into a company's profitability and ability to generate cash, they have distinct differences in terms of what they measure and how they are calculated.

Definition and Calculation

EPS is a measure of a company's profitability that indicates how much profit is allocated to each outstanding share of common stock. It is calculated by dividing the company's net income by the total number of outstanding shares. EPS is often used by investors to assess a company's profitability on a per-share basis.

On the other hand, FCF is a measure of a company's ability to generate cash after accounting for capital expenditures. It represents the cash that a company is able to generate from its operations that is available to be distributed to shareholders, pay down debt, or reinvest in the business. FCF is calculated by subtracting capital expenditures from operating cash flow.

Importance

EPS is an important metric for investors as it provides insight into a company's profitability and earnings potential. A company with a high EPS is generally seen as more profitable and attractive to investors. However, EPS can be manipulated by accounting practices such as share buybacks or changes in the number of outstanding shares, so investors should be cautious when relying solely on EPS to evaluate a company.

FCF, on the other hand, is a more reliable indicator of a company's financial health as it represents the actual cash that a company is able to generate. FCF is important because it shows how much cash a company has available to reinvest in the business, pay dividends, or reduce debt. Companies with strong FCF are generally seen as more financially stable and less reliant on external financing.

Relationship to Stock Price

EPS can have a direct impact on a company's stock price as investors often use EPS to determine a company's valuation. A company with a high EPS relative to its stock price may be seen as undervalued, while a company with a low EPS may be seen as overvalued. However, EPS alone does not provide a complete picture of a company's financial health, so investors should consider other factors when evaluating a stock.

FCF can also influence a company's stock price, as investors may view strong FCF as a positive indicator of a company's financial strength and growth potential. Companies with high FCF may be able to invest in new projects, pay down debt, or return cash to shareholders through dividends or share buybacks, all of which can drive stock price appreciation.

Limitations

While EPS is a widely used metric, it has its limitations. EPS can be easily manipulated by accounting practices such as revenue recognition or changes in the number of outstanding shares. Companies can also use share buybacks to artificially inflate EPS without actually improving profitability. As a result, investors should be cautious when relying solely on EPS to evaluate a company.

FCF also has limitations, as it does not take into account a company's debt obligations or working capital requirements. A company may have strong FCF but still be burdened by high levels of debt or have inefficient working capital management. Additionally, FCF can be volatile and subject to fluctuations in capital expenditures or changes in operating cash flow, making it important for investors to consider FCF in conjunction with other financial metrics.

Conclusion

EPS and FCF are both important financial metrics that provide valuable insights into a company's profitability and ability to generate cash. While EPS is a measure of profitability on a per-share basis, FCF represents the cash that a company is able to generate after accounting for capital expenditures. Both metrics have their own strengths and limitations, and investors should consider a combination of metrics when evaluating a company's financial health and performance.