What Is Earnings Per Share (EPS)?
Earnings Per Share (EPS) is calculated by taking a company’s profit and dividing it by the number of common shares it has out there. This number shows how much profit the company makes for each share. Sometimes, companies change this EPS number a bit to account for unusual things that don’t happen often and for the possibility of having more shares in the future.
Generally, a higher EPS is indicative of greater profitability for a company.
Formula and Calculation for Earnings Per Share (EPS)
The value of Earnings Per Share (EPS) is derived by dividing net income (or profits/earnings) by the number of shares available. A nuanced approach modifies both the numerator and denominator to account for potential shares from options, convertible debts, or warrants. Additionally, adjusting the numerator for ongoing operations makes the equation’s outcome more pertinent.
Earnings per Share = Net Income−Preferred Dividends/End-of-Period Common Shares Outstanding Earnings per Share = End-of-Period Common Shares Outstanding Net Income − Preferred Dividends
To calculate a company’s EPS, data from the balance sheet and income statement are utilized to ascertain the end-of-period total of common shares, any dividends on preferred stock, and the net income or earnings. For greater accuracy, a weighted average of common shares throughout the reporting period is used, acknowledging that the share count may fluctuate over time.
Adjustments are necessary in this calculation to account for any stock dividends or splits, impacting the weighted average of shares outstanding. However, some data sources simplify this process by using the share count at the period’s end.
Example of EPS
Say that the calculation of EPS for three companies at the end of the fiscal year was as follows:
How Is EPS Used?
Earnings Per Share (EPS) is a critical metric for assessing a company’s profitability. It plays a vital role in the calculation of the Price-to-Earnings (P/E) ratio, where ‘E’ represents EPS. By dividing the company’s share price by its EPS, investors can gauge the stock’s value based on what the market is willing to pay per dollar of earnings.
EPS is one of several tools available for stock selection. For those interested in stock trading or investing, the next step involves choosing a broker that aligns with their investment approach.
However, evaluating EPS in isolation might not be significantly meaningful for investors since ordinary shareholders can’t directly access company earnings. Rather, investors typically compare EPS with the company’s share price to assess the value of earnings and gauge market expectations about future growth.
Basic EPS vs. Diluted EPS
Imagine you’re looking at how profitable a company is per share of stock it has. This is where Earnings Per Share (EPS) comes in. There are two types of EPS: basic and diluted.
Basic EPS is pretty straightforward. You take the company’s earnings (how much profit it made) and divide it by the number of shares currently out there. But this doesn’t consider some special kinds of shares that could exist in the future.
Diluted EPS is like basic EPS but with a twist. It includes extra shares that could exist because of things like stock options, warrants, or restricted stock units (RSUs). These are like promises the company makes which can turn into real shares later. If they become real, there are more shares out there, and the profit has to be shared among more shares, usually making EPS lower.
For example, let’s say a tech company like NVIDIA had a way to create 23 million new shares in 2017. If you add these to their existing shares, you get a total of 564 million shares. To find the diluted EPS, divide NVIDIA’s earnings ($1.67 billion) by this new total number of shares (564 million). This gives you $2.96.
Sometimes, you also need to adjust the earnings (the top part of the fraction) when calculating diluted EPS. Let’s say a company took a loan and the lender can choose to turn this loan into shares. If they do, the company wouldn’t need to pay interest on this loan anymore. So, when you’re working out diluted EPS, you add back this interest to the earnings before dividing by the total number of shares. This makes sure the EPS figure is accurate and not too low.
EPS Excluding Extraordinary Items
Earnings Per Share (EPS) can sometimes give a misleading picture of how well a company is doing, either on purpose or by accident. To get a clearer view, analysts sometimes tweak the basic EPS calculation to avoid these distortions.
Let’s use an example to understand this better. Imagine a company that has two factories making cellphone screens. The land where one factory is located has become really valuable because of new developments around it. The company decides to sell this factory and build another on cheaper land. This sale makes a lot of money for the company, which is great, but it’s not something that happens in their regular business.
This profit from selling the land is real money for the company and its shareholders, but it’s called an “extraordinary item.” It’s extraordinary because it’s not something the company can just keep doing over and over. If this one-time profit were included in the EPS calculation, it might make the company look more profitable than it really is in its day-to-day operations. So, analysts leave out these kinds of unusual profits from the EPS calculation.
The same goes for unusual losses. Say, for instance, one of the factories burned down. This would be a big loss for the company but also not a regular occurrence. Including this in the EPS would make the company look less profitable than it usually is. So, analysts exclude these unusual losses too, to give a more accurate picture of the company’s ongoing profitability.
The Formula for EPS Excluding Extraordinary Items Is:
EPS = Net Income−Pref.Div(+or−)Extraordinary Items/Weighted Average Common Shares EPS = Weighted Average Common Shares Net Income − Pref.Div. ( + or − ) Extraordinary Items
EPS From Continuing Operations
If a company began the year with 500 stores and had an Earnings Per Share (EPS) of $5.00, but then closed 100 of those stores, leaving 400 open by year-end, an analyst would be interested in the EPS specifically for those remaining 400 stores. This focus helps in understanding the performance of the parts of the business that will continue operating in the future.
In this scenario, closing the 100 stores could actually raise the EPS. This might happen if those closed stores were losing money. By looking at the EPS from the parts of the business that are continuing — in this case, the 400 stores — an analyst can make a more accurate comparison of the company’s past performance with its current performance, without the noise of the parts of the business that are no longer in operation.
EPS and Capital
A crucial element in evaluating Earnings Per Share (EPS) that’s frequently overlooked is the amount of capital needed to produce the earnings (net income). Imagine two companies both reporting the same EPS. However, if one company achieves this with fewer net assets, it means it’s more efficient in using its capital to generate income. In this context, this more efficient company is considered “better” in terms of capital utilization. To identify which companies are more efficient in this way, a useful metric is the Return on Equity (ROE). This measures how effectively a company uses its equity (the shareholders’ investment) to generate profits.
EPS and Dividends
While Earnings Per Share (EPS) is a popular measure for evaluating a company’s performance, it’s important to note that shareholders don’t directly receive these profits. The company might distribute a part of its earnings as dividends, but it can also choose to retain some or all of the EPS. If shareholders want to access more of these profits, they would need to influence the company’s dividend policy. This is typically done through their representatives on the board of directors, who have the authority to decide the portion of EPS that should be distributed as dividends.
EPS and Price-to-Earnings (P/E)
Comparing the Price-to-Earnings (P/E) ratio among companies in the same industry can be useful, but sometimes it’s surprising. You might think that a stock that has a higher price compared to its earnings per share (EPS) than its industry peers is “overvalued,” but often, it’s actually the other way around. Regardless of its historical EPS, investors are willing to pay more for a stock if it is expected to grow or outperform its peers. In a bull market, it is normal for the stocks with the highest P/E ratios in a stock index to outperform the average of the other stocks in the index.
The Bottom Line
Earnings per Share (EPS) is determined by dividing a company’s profit by its total number of outstanding common shares. This figure represents the company’s profitability on a per-share basis. Companies often adjust EPS for extraordinary items and possible share dilution effects.