Earnings per share (EPS) tells investors a company’s ability to produce income for shareholders, and relates to its profitability. To calculate EPS, investors can use a ratio that takes a company’s quarterly or annual net income and divide it by the number of outstanding shares of stock on the market.
Knowing a stock’s earnings per share can be a valuable portfolio benchmarking tool. Think of EPS as GPS for where a public company is on the value map, based on how profitable it has been. Further, knowing an investment’s EPS gives investors — and portfolio managers — a good indicator of a stock’s performance over a specific period of time and its potential share price performance in the near future.
Key Points
• Earnings per share (EPS) is a ratio that measures a company’s ability to generate income for shareholders.
• EPS is calculated by dividing a company’s net income by the number of outstanding shares of stock.
• EPS is a valuable tool for benchmarking a company’s profitability and assessing its potential share price performance.
• Basic EPS includes all outstanding stock shares, while diluted EPS considers additional assets like convertible securities.
• EPS may help investors evaluate a company’s financial health, make investment decisions, and assess risk.
What Is Earnings Per Share (EPS)?
The starting point for any conversation about the EPS ratio is the earnings report companies issue to regulators, shareholders, and potential investors. Earnings reports play a major role, if not the starring role, during earnings season.
Publicly traded companies must, by law, report their earnings quarterly and annually. Earnings represent the net income a company generates (after taxes and after expenses are deducted), along with an estimate of what profits or losses can be expected going forward.
Typically, investment analysts, money managers and investors look at earnings as a major component of a company’s profit potential, with earnings per share a particularly useful measurement tool when gauging a company’s financial prospects.
While a company’s earnings call represents a publicly traded company’s revenues, minus operating expenses, earnings per share is different.
EPS indicates a firm’s earnings for investors, divided by the company’s number of remaining shares. Earnings per share is perhaps most optimal when comparing EPS rates of publicly traded firms operating in the same industry.
It is likely not, however, the only investment measurement tool when researching stocks and funds. Other key indicators, like share price, market share, market capitalization, dividend growth, and historical performance may also be added to the investment assessment mix. In all, though, it’s an important tool that can help determine the investing risk at play when making investing decisions.
If you’re wondering how to find earnings per share, investors can find a company’s quarterly and yearly EPS by visiting the firm’s investor relations page on its website or by plugging in the stock’s ticker symbol on major business and finance media platforms.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
Basic and Diluted EPS
When companies report earnings per share, they may do so in two forms: basic EPS or diluted EPS. Each has key distinctions that investors should know about. Basic EPS is a good barometer of a firm’s financial health, while diluted EPS represents a deeper dive into a company’s financial metrics and its use of alternative assets like convertible securities.
Basic
Basic earnings per share, or basic EPS, includes all of a publicly traded company’s outstanding stock shares.
Diluted
Diluted earnings per share, or diluted eps, includes all of a company’s outstanding stock shares, plus its investable assets, like stock options, stock warrants, and other forms of convertible investments tied to a company’s financial performance that could become common stocks one day.
One big takeaway for both EPS models is that any major deviation between basic and diluted EPS calculations should be considered a warning sign to investors, as it indicates that a company’s use of convertible securities is complicated and still in flux.
That scenario may indicate that the company isn’t in an ideal position to provide accurate share value to the investing public at a given time.
Why Is EPS Important to Investors
EPS calculations are not only a snapshot of a company’s profit performance, but they can also be used to evaluate a company’s stock price going forward. Even a moderate increase in EPS may indicate that a company’s profit potential is on the upside, and investors may take that as a sign to buy the company’s stock.
Conversely, a small decrease in a company’s EPS from quarter to quarter may trigger a red flag among investors, who could view a downward EPS trend as a larger profit issue and shy away from buying the company’s stock.
In short, the higher the EPS, the more attractive that company’s stock generally is to investors. But the higher a stock’s EPS, the more expensive its shares are likely to be.
Once investors have an accurate EPS figure, they can decide if a stock is priced fairly and make an appropriate investment decision.
What Is Considered a Good EPS Ratio?
There’s no hard and fast figure to point to when trying to determine a good EPS ratio. It’s perhaps better practice to look, in general, for a higher number. Context is important, too, because whether an EPS is good may depend on the expectations surrounding it.
Companies grow at different rates, and some are in different stages of growth than others. With that in mind, you might expect a different EPS for, say, a tech startup than you would for a decades-old auto manufacturer. So, there are differences and contexts to take into consideration.
But again, it may be best to look for a high number — or, to do some research to figure out what analysts and experts are looking for in terms of a specific company’s EPS. Again, this can all help you determine whether a stock is right for your portfolio and strategy in accordance with your tolerance for risk.
💡 Quick Tip: How to manage potential risk factors in a self directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Earnings Per Share Ratio Considerations
Investors should prepare to dig deeper and examine what factors influence EPS figures. These factors are at the top of that list:
• EPS numbers can rise or fall significantly based on earnings’ rise or fall, or as the number of company shares rises or falls.
• A company’s earnings may rise because sales are surging faster than expenses, or if company managers succeed in curbing operations costs. Additionally, investors may get a “false read” on EPS if too many company expenses are shed from the EPS calculation.
• A company’s number of outstanding shares may fall if a company engages in significant stock share buybacks. Correspondingly, shares outstanding may jump when a firm issues new stock shares.
• A company’s profit margins are also a big influencer on EPS. A company that is losing money usually has a negative EPS number. (Then again, that may send a wrong signal to investors. The company could be on the path to profits, and that trend may not show up in an EPS calculation.)
• A price to earnings ratio is another highly useful metric to evaluate a stock’s share growth potential. Investors can find a P/E ratio through a proper calculation of EPS (“P” is the price per share; “E” refers to EPS), though it’s easy to look up a P/E ratio on any site that aggregates stock information.
EPS can be reported for each quarter or fiscal year, or it can be projected into the future with a forward EPS.
How to Calculate EPS
The EPS formula is fairly simple, and it can be used in a couple of different methods, too. The most common way to accurately gauge an EPS figure is through an end-of-period calculation.
EPS Formula
The EPS formula is a company’s net income, minus its preferred dividends, divided by the number of shares outstanding. It looks like this:
EPS = (net income – preferred dividends) / outstanding shares
EPS is perhaps usually calculated using preferred dividends, but it can be calculated without them, too. Here are a couple of examples:
Example With Preferred Dividends
Investors can calculate EPS by subtracting a stock’s total preferred dividends from the company’s net income. Then divide that number by the end-of-period stock shares that are outstanding.
Basic EPS = (net income – preferred dividends) / weighted average number of common shares outstanding
For example, ABC Co. generates a net income of $2 million in a quarter. Simultaneously, the company rolls out $275,000 in preferred dividends and has 12 million outstanding shares of stock. In that calculation, knowing that shares of common stock are equal in value, the company’s earnings per share is $0.14.
(2,000,000 – 275,000) ÷ 12,000,000＝ 0.14
Example Without Preferred Dividends
For smaller publicly traded companies with no preferred dividends, the EPS calculation is more straightforward.
Basic EPS = net income / weighted average number of common shares outstanding
Let’s say DEF Corp. has generated a net income of $50,000 for the year. As the company has no preferred shares outstanding and has 5,000 weighted average shares on an annual basis, its earnings per share is $10.
50,000 ÷ 5,000＝ 10
In any EPS calculation, preferred dividends must be severed from net income. That’s because earnings per share is primarily designed to calculate the net income for holders of common stock.
Additionally, in most EPS end-of-period calculations, a company is mostly likely to calculate EPS for end-of-year financial statements. That’s because companies may issue new stock or buy back existing shares of company stock.
In those instances, a weighted average of common stock shares is required for an accurate EPS assessment. (A weighted average of a company’s outstanding shares can provide more clarity because a fixed number at any given time may provide a false EPS outcome, as share prices can be volatile and change quickly on a day-to-day basis.)
The most commonly used EPS share model calculation is the “trailing 12 months” formula, which tracks a company’s earnings per share by totaling its EPS for the previous four quarters.
The Takeaway
Earnings per share (EPS) can be calculated by investors to get a better sense of a company’s ability to produce income for shareholders. To calculate EPS, investors can use a ratio that takes a company’s quarterly or annual net income and divide it by the number of outstanding shares of stock on the market. There are different variations of the calculation, too.
Earnings trends, up or down, make earnings per share one of the most valuable metrics for assessing investments. Four or five years of positive EPS activity is considered an indicator that a company’s long-term financial prospects are robust and that its share growth should continue to rise.
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FAQ
How do you calculate EPS by year?
To calculate EPS by year, investors can use the formula that subtracts preferred dividends from net income, and then divide that number by the weighted average of common shares outstanding for the given year.
What is a good EPS ratio?
Each company is different, as is the context surrounding it, so there is no general rule about what makes a “good” EPS ratio for any given stock. Instead, investors should gauge analyst expectations, and consider a company’s age, among other things, to determine if its EPS is good or bad.
What are the two ways to calculate EPS?
Earnings per share (EPS) can be calculated with preferred dividends, or without preferred dividends, depending on the specific company.
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