If you’ve ever looked at a company’s earnings report, you’ve probably come across EPS (Earnings Per Share). But what exactly does it mean and how do you calculate EPS?
Simply put, EPS is a metric in a company’s financials that tells you how much profit a company makes for each share of its stock. It’s one of the most commonly used metrics by investors and analysts to gauge a company’s profitability. Another way to think of it as the slice of the company’s profit that belongs to each shareholder.
How Do You Calculate EPS?
It’s actually pretty straightforward. Here’s the formula:
EPS = (Net Income – Preferred Dividends) //Total Number of Outstanding Common Shares. Below is a breakdown of these parameters:
- Net Income – Net Income is a company’s profit after it’s paid all its expenses, taxes, and other obligations.
- Preferred Dividends – These are payments made to preferred shareholders first. The preferred dividends are subtracted so that we get to the figure allocated to common shareholders.
- Outstanding Shares – This is the total number of regular or common shares that are currently held by all its investors. These include company insiders, institutional investors, retail investors and any other shares held and available for public trading.
A Working Example of How to Calculate EPS
Let’s take an example of a company that has just earned $100 million in net income and has apportioned $10 million to go to preferred shareholders. Assuming the company has 50 million common shares, the EPS will be calculated as follows:
EPS = ($100 million – $10 million) / 50 million shares EPS = $90 million / 50 million shares EPS = $1.80 per share.
So, for every share traded, the company earned $1.80 in profit. That can add up to a tidy sum for investors who own hundreds or thousands of shares.
Why Does EPS Matter?
Typically, a company with a higher EPS is usually more profitable. When that happens, shareholders stand to gain from either an increase in dividends or a general uptick in the stock price.
But, it doesn’t end there-investors often compare a company’s current EPS to previous quarters or to other companies in the same industry to see how well it’s doing.
Types of EPS
- Basic EPS – This is EPS calculated using the common shares held by investors.
- Diluted EPS – This one includes things like stock options or convertible bonds that could increase the share count in the future and cause the dilution of the value of each stock. They incorporate “worst-case” scenario for EPS.
- Reported or GAAP EPS – EPS based strictly on the Generally Accepted Accounting Principles (GAAP).
- Ongoing or Pro Forma EPS – Strips out one-time or unusual items to give a better picture of regular earnings.
Why Is EPS Important?
EPS is more than just a number—it’s a signal.
- It shows how profitable a company is on a per-share basis.
- It’s used to calculate the P/E ratio (Profit-to-Earnings ratio), a major tool in stock valuation. Note that P/E ratio is calculated by dividing a company’s share price by the EPS.
- It helps you compare companies, even if they’re totally different sizes.
- And most importantly, it helps you make smarter investment decisions.
Bottom Line
Understanding EPS helps you get a better read on a company’s performance. But like any financial metric, it works best when used alongside other metrics. So, it’s good to keep an eye on EPS, but don’t forget to look at the bigger picture too.