What is Earnings Per Share?
Earnings Per Share (EPS) is an important and closely watched metric in a company’s earnings figures. It is one of the numerous tools investors can draw from their arsenal to help them analyze the profitability, health, and overall value of a business. Simply put, EPS represents the amount of money a company earns for each share of its common stock. It tells us how profitable a company’s shares are compared to others. A higher EPS is synonymous with higher profitability.
Learn what earnings per share is, how it’s calculated, why it’s important for investors, and the types of EPS.
What Is Earnings Per Share?
Earnings per share is the portion of a company’s profit attributed to each share of its outstanding stock (the number of shares currently held by stock owners). It is arrived at by taking the net income and dividing it by the total shares outstanding or currently held by shareholders. The Securities and Exchange Commission (SEC) requires that publicly traded companies file their quarterly and annual financial reports. A company’s net income can be obtained from these financial reports.
Earnings per share is a yardstick for a company’s profitability and provide insights into whether a company is a safe bet. To put things into perspective, EPS could be described as the money each share of a company’s stock would receive if profits were distributed to shareholders at the end of the quarter or fiscal year.
Often expressed as a ratio, earnings per share takes into account the weighted average number of shares since shares outstanding vary throughout the fiscal year. This helps eliminate the variability and accounts for a company’s profitability over extended periods.
How to Calculate Earnings Per Share
Although you’ll often find EPS listed on a company’s quarterly or annual financial report, it’s equally important that you know how to get this ratio. To calculate earnings per share, you’ll take a company’s net income and divide it by the number of common shares outstanding. The formula is written as:
Earnings per share = Net income / Common shares outstanding
In some cases, the EPS formula is written as follows: EPS = (Net income – preferred dividends) / weighted average shares outstanding. This formula takes into account preferred shares, though most companies don’t have these. For those that do, dividends from preferred shares are deducted from the net income because preferred dividends are paid before dividends from common stock.
You can easily find the two data points used to calculate the EPS ratio in a company’s earnings report. While the net income is rather straightforward, the number of outstanding shares can be calculated in two ways. First, you can get the total share count from a company’s income statement at the end of a reporting period. However, since total shares outstanding may fluctuate, a second, more accurate method is obtaining the weighted average of the shares outstanding. We can calculate the weighted average shares outstanding by adding dividends distributed during each reporting period and then dividing the sum by the number of reporting periods.
For a more accurate tally, you must account for events that may increase or reduce the share count, say stock splits, stock buybacks, stocks issuance, or stock dividends. Investors can calculate earnings per share on a quarterly and annual basis.
Let’s use an example to better understand EPS.
For the year that ended Dec. 31, 2021, Company ABC reported a net income of $100,000,000 and 10,000,000 common shares outstanding. The company had no preferred stock and neither issued nor repurchased new shares. Therefore, the EPS of Company ABC is:
Earnings per share = Net income / Common shares outstanding
Earnings per share = 100,000,000 / 10,000,000 = 10
Therefore, the EPS = $10 per share
If a company has preferred dividends, deduct them from the net income before dividing by the shares of stock outstanding. Let’s use an example to demonstrate this second case:
For the year ending Dec. 31, 2021, Company XYZ posted a net income of $5,000,000 and paid out $800,000 in preferred dividends. If the average shares of common stock outstanding for the period were 1,000,000 shares, the company’s EPS is:
Earnings per share = (Net income – preferred dividends) / Average shares outstanding
Earnings per share = (5,000,000 – 800,000) / 1,000,000 = $4.2 per share
Why Earnings Per Share Is Important for Investors
Earnings per share is a crucial metric for investors examining a company’s fundamentals. However, investors can use EPS for more than just assessing profitability. Here are some clues you can deduce from earnings per share.
It Drives Stock Prices
Investors can monitor EPS since it is a driver of stock prices. If a company posts solid earnings or beats earnings expectations for a quarter or fiscal year, it may be an indicator that the EPS has also risen, and stock prices may soar. Similarly, if earnings come short, the EPS may follow suit, and stock prices may plummet. Even so, this prediction may not always materialize.
Earnings per share is a barometer of a company’s profitability. When analyzing fundamentals, EPS isolates net income to provide insight into what shareholders are getting from their investment in the company. Companies conduct business to make profits, and investors are always looking to partake in the profits.
A growing EPS shows that investors are receiving a portion of the company’s profits. This is also a sign of a company that’s creating value for its investors. On the flip side, negative EPS portrays consistent losses, low profitability, and diminishing investor value. EPS answers two important questions: how much profit per share of outstanding common stock is the company delivering? And, how much profit does a shareholder earn?
Calculating Other Financial Metrics
Investors can leverage the correlation of EPS to other financial ratios to further evaluate a company’s performance. Other financial metrics you can obtain using the EPS ratio include:
- Price-to-Earnings (P/E) Ratio: The P/E ratio measures a company’s share price relative to the EPS. If a company’s stock price is $20 and its EPS for the year is $5, then its P/E ratio is 4. This implies that it would take four years to earn back the $20 spent on the stock.
- Earnings yield: You can invert the P/E ratio to obtain earnings yield, usually the percentage of a company’s EPS.
Types of EPS
The standard EPS calculation gives the basic EPS. There are also other types of EPS as follows:
- Diluted EPS: Diluted EPS factors in a company’s convertible debt and its employee stock options.
- Adjusted EPS: The adjusted EPS calculation fine-tunes the numerator by removing or adding non-recurring components of the net income, say the one-time sale of a building.
- EPS from continuing operations: This calculates EPS from a company’s daily operations.
Understanding Your Earnings Per Share
Earnings per share is a quick calculator for a company’s financial health and profitability. Although positive EPS activity indicates a company’s positive financial prospects, it may not reveal all the intricacies. Companies issuing stock, buying back shares, or performing stock splits could easily manipulate this figure. So, besides profitability, ensure your investment in a company aligns with your goals.