Earnings Per Share (EPS): Definition, Formula & Example
Entrepreneurs are always looking for ways to increase their performance and become more competitive. Financial ratios are something that can get used to evaluate performance and gain insights into how to gain that competitive edge. But where do you start and what are the most beneficial ratios to use?
It can often depend on what you’re looking for, but ratios help measure the relationship between certain components of financial statements. Ultimately, financial ratios can play a critical role in improving your business.
One of the most common is the earnings per share (EPS) ratio. So how does it work and what do you need to know? Don’t worry, we compiled this guide to break down the most important aspects. Keep reading to learn more about EPS and the formula to calculate it!
Table of Contents
- To calculate EPS, you take a company’s net profit and divide it by the number of shares outstanding.
- Having a higher EPS can indicate a company is more valuable and profitable. This is since investors will typically purchase shares for a higher amount when profits are higher relative to the share price.
- EPS is a widely used financial metric that helps indicate the profits of a company based on each share of its stock price.
What Is Earnings Per Share (EPS)?
Earnings per share (EPS) is a financial ratio and metric that’s commonly used by investors to value a stock. It can also get used to value a company since it’s able to show insights into how profitable it is on a per-share basis. You calculate EPS by taking the profit of a company and dividing it by any outstanding shares of its common stock.
The number you end up with helps indicate the total profitability of a company. Having a higher EPS means that the company is highly profitable. It can also be common to report EPS that gets adjusted for things like potential share dilution and other extraordinary items.
How to Calculate EPS
To keep things as simple as possible, EPS gets calculated by dividing the net income of a company by the available shares. Net income can also commonly get referred to as earnings or profits.
You can take it a step further by adjusting certain elements of the calculation. For example, shares might get created through other things such as warrants, options, or convertible debt. To calculate the EPS of a company, you’re going to need to have access to and use the income statement and balance sheet.
In doing this, you will then want to find the period-end number of the common shares. As well, you will want to find any dividends paid on preferred stock and the total earnings or net income.
Since the shares can fluctuate over time it’s also useful to use a weighted average number of common shares. This provides for a little more accuracy. Plus, any potential stock dividends or splits that happen are going to need to get reflected in the calculations. You can simplify this even further by finding the number of shares that are outstanding at the end of a specific period.
There can be more than one earnings per share formula depending on what metrics you use. They would look like this:
How Does EPS Get Used?
Determining EPS is often one of the most important financial metrics you can use. It helps with finding out the profitability of a company and it can get translated into other valuation ratios. For example, earnings per share can play a major role when calculating the price-to-earnings or P/E valuation ratio.
The E in the P/E ratio rates to the EPS. When you’re able to divide the share price of a company by its overall earnings, investors gain insights into the total value of a stock. They’re able to see how much the market would be willing to invest for each dollar of earnings.
Investors and analysts regularly use EPS as an effective indicator when looking into certain stocks.
Example of EPS
Let’s say that you want to find out the earnings per share of a company. After doing some research and analysis, you have determined that Company A has a total net income of $2 million in its third quarter.
As well, the company has announced dividends totaling $250,000 and the total number of shares outstanding is 12 million. To calculate EPS, you can input these numbers into the formula. It would look like this:
($2,000,000 – 250,000) / 12,000,000 = 0.145
Because each share will end up receiving an equal portion of the net income, they would each get $0.145.
Basic EPS vs Diluted EPS
Basic EPS and diluted EPS are both used to help calculate and measure a company’s profitability. Basic EPS takes into account the outstanding equity shares that a company has. While diluted EPS includes calculations for convertible shares.
Some common convertible shares can include warrants, employee stock options, bonds, and any debt. Investors often use both basic and diluted EPS calculations to analyze a company.
Formulas for Basic EPS and Diluted EPS are as follows:
What Are the Limitations of EPS?
One of the primary limitations of calculating EPS to value a stock or company is that it only uses net income. This means that depending on the company some calculations can fluctuate. For example, you would typically subtract non-cash expenses such as amortization and depreciation, from net income. So certain capital expenditures can cause the net income of a company to vary over different reporting periods.
As well, different businesses might have completely different non-operating expenses like interest payments and taxes. These are also going to affect the overall net income of the company. So at its core, net income isn’t always going to provide a fully accurate look into the health or cash flow of a business.
Companies also regularly change the number of shares outstanding to try and manipulate their EPS. Things like stock buybacks, splits, and share issuances will all change and affect the denominator.
Earnings per share is a handy metric that investors and analysts use to value a stock or a company. It shows insights into how profitable they might be based on a per-share basis. It’s fairly simple to calculate EPS, as all you need to do is find the profit of a company and divide it by the outstanding shares.
Depending on the number you find, it’s going to determine whether or not a company is profitable. However, there are certain limitations to EPS. For example, things like non-cash expenses and capital expenditures can cause a company’s net income to vary. All of these things can be found using accurate financial reporting and examining business performance.
Earnings Per Share (EPS) FAQs
Not quite. EPS has to do with the net profit that’s earned by a company. Dividends, on the other hand, are how a company distributes its profits to its shareholders.
Since EPS measures the earnings that are attributable to the shares of common stock, it differs from ROE. ROE is the measure of return that shareholders get in return from their investments.
It depends on what type of stock you invest in and your long-term goals. But selling part of a growth stock before it reports earnings can be a solid strategy.
Certain financial metrics can fluctuate or get manipulated by companies to boost their EPS. However, a stock with an 80 or above rating will typically have a good chance of success and high profitability. Companies try to boost their EPS through things like stock buybacks to help reduce outstanding shares.
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