What is Earnings Per Share?
Earnings per Share or EPS refers to figure one obtains by dividing a company’s profit with the outstanding shares of its common stock. It serves as one of the indicators for finding out the profitability of a company. Companies commonly report their EPS after adjusting it for potential share dilution and other extraordinary items. Investors usually consider a company with a higher EPS as more profitable and attractive.
The Earnings Per Share forms the bottom line on an income statement, which is typically separated into parts.
- The company’s direct costs, resulting in gross margin and net revenue
- The company’s indirect costs, resulting in operating income
- The company’s net income which is calculated by subtracting tax and interest from the EBIT
- Breakdown of earnings per share
The breakdown of the EPS is done in 2 ways. Public companies have to report both diluted earnings per share and basic earnings per share. The net income divided by the number of total available shares, including convertible and free float shares, gives us the diluted earnings per share. The net income divided by active, free float shares in the market gives us the basic earnings per share.
Real stock Earnings Per Share Example
One can calculate the Earnings per Share of a company using any one of two ways. The first way is to subtract the net income by the preferred dividends, dividing the result by the weighted average shares outstanding. The other way is to subtract the net income by preferred dividends, dividing the result by the end of the period shares outstanding. In actuality, most investors use the 2nd method when they calculate the dominator of the equation.
For instance, let us take $2 million as the net income for a company “ABC” for the 2nd quarter of 2019. The company announces $275,000 worth of preferred dividends. The total number of outstanding shares is 12 million. Here, the EPS = ($2,000,000-$275,000)/12,000,000, which gives us $0.14. Each share receives 14 cents as common shares receive equal earning. Some investors and analysts can use either a diluted EPS or a normalized EPS.
A Diluted EPS understates the actual EPS entitled to shareholders. It is done as some companies can have outstanding dilutive securities. That increases the number of outstanding shares. The EPS is thus dilutive as the total number of outstanding shares increases as options converted into outstanding shares.
For instance, let us say that the Company ABC has stock options which are convertible to 2 million shares outstanding. We get a total of 14 million shares outstanding in this case. Thus the dilutive EPS is $0.12, which less than the basic EPS.
A normalized EPS, on the other hand, tends to give us a more accurate picture of the financial health of a company. This type of adjustment to a company’s income statement considers one-off expenses and reflects the cycles of the economy. It may not reveal a company’s actual profitability.
Example of the basic EPS of three companies for the end of the fiscal year 2017
Weighted Common Shares
Bank of America
Simple Way to Value Stock Using EPS
EPS is one of the most important indicators that investors use to pick stocks. Investors may not have much interest in comparing absolute EPS. This is because earnings cannot be directly accessed by ordinary shareholders. They instead compare the EPS with the share price of the stock, determining the value of earnings.
Ultimately, it is a company’s earnings that drive up a stock’s price, so analysts and investors pay close attention to it. The stock price may increase if a company’s earnings are strong for the quarter. Alternatively, a decrease in earnings may indicate that the stock price might decrease as well. Any increase can be a positive sign for the future. However, Investors can never really guarantee this prediction because of the other factors role played in stock evaluation.
For instance, during the dot-com boom, the earnings for many companies came in less than the predictions made by investors. Initially, stock prices skyrocketed as investors felt excited about the growth potential of the companies in question. Eventually, however, the high valuations of the companies plummeted as they could not earn enough to keep up with the predictions.
Thus, investors can evaluate a stock’s EPS when they are considering purchasing. A positive EPS may indicate that the company is on track towards profitability. However, many companies manipulate their EPS by buying back their own shares and not taking outstanding debt into account.