Earnings per share (EPS) is a measure that signifies how much profit each outstanding share of a company’s common stock has earned. It’s derived by dividing the company’s net income by the total number of outstanding shares, highlighting how each share contributes to overall profitability.
The higher the EPS, the more profitable the company is deemed to be.
Key Takeaways
- EPS is calculated by subtracting preferred dividends from the net income and dividing by the number of common shares outstanding.
- It represents how much profit a company makes for each share of its stock and is a critical metric for assessing corporate value.
- A higher EPS suggests greater value because investors pay more for shares if they see higher profits relative to share price.
- EPS is most insightful when compared with competitors, industry standards, or across different time periods.
The EPS Equation Simplified
EPS is calculated as net income (profits/earnings) divided by the available shares. Adjustments are often made to account for potential shares created through options, convertible debt, or warrants, making the numerator more relevant by focusing on continuing operations.
Earnings per Share = \frac{Net Income − Preferred Dividends}{End-of-Period Common Shares Outstanding}
To determine EPS, refer to the balance sheet and income statement to identify the period-end number of common shares, any preferred dividends, and net income. Ensure stock dividends or splits are reflected in the weighted average number of outstanding shares for accuracy.
EPS In Action: A Practical Example
Consider the following EPS calculations for three companies at the end of their fiscal year:
| Company | Net Income | Preferred Dividends | Weighted Common Shares | Basic EPS |
|---|---|---|---|---|
| Company A | $7.6B | $0 | 3.98B | $1.91 |
| Company B | $18.23B | $1.61B | 10.2B | $1.63 |
| Company C | $1.67B | $0 | 0.541B | $3.09 |
##. The Impact of EPS
EPS is a fundamental metric for determining a firm’s profitability. It is a major component for calculating the price-to-earnings (P/E) ratio, indicating stock value in relation to earnings. Investors view EPS in conjunction with the share price to evaluate a company’s value and growth potential.
Basic EPS vs. Diluted EPS
Basic EPS considers the net income over the basic amount of shares. Diluted EPS considers all potential shares that could be outstanding. Diluted EPS would always be equal to or lower than the basic EPS as it takes stock options, warrants, or restricted stock units into the equation. For instance, if Company C’s convertible instruments potentially added 23 million shares by year-end, the diluted EPS would be calculated with these new shares included.
##. The Significance of Accurate EPS Calculation
Isolate and exclude extraordinary items or discontinued operations when calculating EPS to prevent distortion. For example, gains from a one-time real estate sale should not falsely enhance the EPS as such transactions are usually non-recurring.
##. EPS from Continuing Operations
Adjust EPS to reflect ongoing operations if a firm undertakes substantial operational changes, like closing underperforming stores. This calculation helps in accurate year-over-year performance comparison.
EPS Beyond the Numbers
Not all earnings are accessible to shareholders directly as dividends, as some may be retained by the company. Comparing similar EPS values doesn’t convey efficiency, which is better captured through return on equity (ROE).
The Bottom Line
Earnings per share is a pivotal metric for assessing financial health and aiding investment decisions. Higher EPS signifies better performance but must be contextualized alongside dilution potential and industry standards for actionable insights.
Related Terms: Net Income, Preferred Dividends, Common Shares Outstanding, Price-to-Earnings Ratio (P/E Ratio), Diluted EPS, Adjusted EPS
