Earnings per share (EPS) is the portion of a company's profits that is available to its common stockholders. Investors keep a careful watch on this metric, which they use to evaluate a company's performance.
The profit of a firm is divided by the number of outstanding shares of its common stock to compute earnings per share. The resulting figure is used to determine a company's profitability.
It is typical for a corporation to announce earnings per share (EPS) that have been adjusted for extraordinary items and probable share dilution.
The higher a company's earnings per share, the more profitable it is thought to be.
Also, earnings per share (EPS) is a prominent metric used by investors to value a stock or company since it shows how lucrative a company is per share.
Calculation of Earnings Per Share (EPS)
A company's EPS is computed by deducting any preferred dividends from its net income and dividing the result by the number of shares that are outstanding.
After all cash and non-cash expenses are eliminated, net income is the amount of money leftover in a reporting period, and net income less preferred dividends equals a company's profit for that period.
Because preferred stockholders have contract rights to dividend payments, preferred dividends must be deducted.
For more clarity, EPS is calculated by dividing a company's net income (excluding any preferred share dividends) by the number of common shares outstanding.
The weighted average number of shares outstanding over the period ending is a typical way to express the number of outstanding shares.
The formula is as follows:
(Net Income - Preferred Stock Dividends) ÷ Number of Common Shares Outstanding.
The balance sheet and income statement are often used to find the end of the period number of common shares, dividends paid on preferred stock (if any), and net income or earnings to determine a company's EPS.
Because the number of common shares might fluctuate over time, using a weighted average number of common shares across the reporting period is more appropriate.
Any stock dividends or splits must be factored into the weighted average number of shares outstanding computation. The number of shares outstanding after a period is used by some data sources to make the calculation simple.
How is the EPS used?
When measuring a company's profitability on an absolute level, earnings per share is one of the most essential measures to consider. It's also a big part of figuring out the price-to-earnings (P/E) ratio, where the E stands for earnings per share.
An investor can determine the value of a stock by dividing its share price by its earnings per share to discover how much the market is prepared to pay for each dollar of earnings.
One of the many measures you can use to pick stocks is earnings per share (EPS). If you're interested in stock trading or investing, the next step is to find a stockbroker that can accommodate your investment preferences.
Because ordinary shareholders do not have easy access to earnings, comparing EPS in real numbers may be pointless to investors.
Investors will rather compare EPS to the stock's share price to gauge the worth of earnings and how optimistic they are about future growth.
Basic EPS Vs. Diluted EPS
Investors can see how much of a company's net income was allocated to each share of common stock using basic earnings per share (EPS). It appears on a company's income statement and is particularly useful for companies with solely common stock as a capital structure.
The amount of profit that can be given to one share of a company's common stock is called basic earnings per share.
Companies having simple capital structures, in which only common stock has been issued, might expose their profitability by releasing this ratio. The dilutive impact of convertible instruments is not taken into account in basic earnings per share.
Basic EPS = (Net Income - Preferred Dividends) ÷ Weighted Average of Common Shares Outstanding During the Period.
The diluted EPS is normally lower than the simple or basic EPS, but it might be higher in the unusual instance of anti-dilutive securities. In this instance, the financial statements only show the basic EPS.
When all convertible securities are exercised, diluted EPS is used to assess the quality of a company's earnings per share (EPS). All outstanding convertible preferred shares, convertible debentures, stock options, and warrants are considered convertible instruments.
Diluted EPS = (Net Income − Preferred Dividends) ÷ Weighted Average Shares Outstanding + Conversion of Dilutive Securities.
A substantial gap between a company's basic EPS and diluted EPS can imply a high risk of dilution for the company's shares, which most analysts and investors find undesirable.
Earnings Per Share and its Limitations
The fact that EPS is calculated using net income is the fundamental drawback of using it to appraise a stock or company.
Depreciation and amortization are non-cash charges that are removed from net income, and the irregular nature of capital expenditures can cause a company's net income to vary substantially between reporting periods.
Non-operating expenses, such as tax and interest payments, can affect net income in a variety of ways. Net income does not fully reflect a company's cash flow or the health of its operations.
Furthermore, firms can and do manipulate their EPS numbers by altering the number of outstanding shares. The denominator by which net income less preferred dividends is divided changes as a result of share issuances, splits, and stock buybacks.
When EPS figures are compared to other indicators, they are more relevant.
The price/earnings (P/E) ratio, which compares a firm's stock price to its earnings per share (EPS), and the return on equity (ROE), which shows how much profit a company earns from its net assets, are the two most prevalent metrics.
Difference between EPS and adjusted EPS
Companies frequently declare EPS values based on net income adjusted for one-time earnings and expenses, such as business unit sales or natural disaster losses.
While adjusted EPS might be a better indicator of a company's profitability, some organizations adjust their net profits in misleading or deceptive methods to improve their adjusted EPS numbers.
What is a good EPS?
What makes a good EPS is decided more by its year-over-year change than by its actual number. Annually, a company's EPS should improve in absolute value, but the rate of increase of its EPS should also rise.
The EPS of a corporation might fluctuate due to changes in earnings, the total number of shares outstanding, or both. A company's EPS can be boosted by growing earnings or dropping its share count through share buybacks, but a company's EPS will be lowered if its outstanding share count grows faster than its earnings.
Stock investors can assess a company's EPS further by comparing it to its P/E ratio and assessing how the stock price has fluctuated in relation to its earnings.