An illustration as to why EPS can be very misleading.
Consider an acquisition of assets (this can range from a piece of property to an entire firm) by a particular firm; acquisitions are often made for a few reasons – revenue enhancement, cost reduction, tax gains, and reduced capital requirements. The buzzword here is synergy and these are all examples of synergies arising from acquisitions.
Under an acquisition with synergy, the value of the combined entity will be higher than the sum of the individual entities. Conversely, under an acquisition with no synergy, the value of the combined entity will be equal to the sum of the individual entities and no value is created for shareholders.
Numerical Hypothetical Example (without synergy)
EPS = $5, P/E = 20, 10,000 shares
Price per share = $100
EPS = $2, P/E = 10, 5,000 shares
Market value …