Earnings Per Share (EPS)

What Is Earnings Per Share (EPS)?

Earnings per share also known as EPS is a fundamental analysis tool that majors the company’s profitability. One can get the earnings per share by dividing the net profit of the company by the total outstanding common shares.

Most of the companies report earnings per share (EPS), adjusted for potential share dilution and extra-ordinary items. With more earnings per share (EPS) company is considered more profitable and vice versa.

Calculation And Formula For Earnings Per Share (EPS)

Earnings per share (EPS) can be calculated by dividing the net profit of the company by the total outstanding common shares (equity shares) of the company.

Basic formula:

Earning Per Share (EPS) = (Net-profit – Preferred Dividend)/ Weighted average common shares

Net income formula:

Earning Per Share (EPS) = (Net-profit – Preferred Dividend)/ Average common shares

Operating EPS Formula:

Earning Per Share (EPS) = (Operational profit – Preferred Dividend)/ Weighted average common shares

A company’s EPS can be calculated by, finding the number of common shares, dividends on preferred stock (if paid), and the net profit or earnings in the balance sheet and income statement.

The most accurate way to calculate the EPS by using the weighted average number of common shares, as the number of shares can change over time if any corporate action takes place.

Example

Let’s assume a company’s net profit for a period is $100 million, the number of outstanding shares for that period is $20 million and paid a dividend of $20 million on preferential shares. So what will be the Earnings per share (EPS) of the company?

Earnings Per share (EPS) = ($100 million – $20 million)/20 million = 4

Basic Vs Diluted EPS

The above formula is to calculate the basic EPS, but it is not the most accurate one as basic EPS ignores the diluted share and other instruments. A company’s capital structure includes stock options, warrants, and other debt instruments that may be issued by a company.

So in order to get the exact and accurate earnings per share the diluted EPS formula is used.

Formula For Diluted EPS

Diluted EPS = (Net Income + Convertible Preferred Dividend + Debt Interest)/(All convertible securities + common shares)

Cash EPS

Cash Earnings per Share, also known as cash EPS, is a type of EPS that is determined by calculating cash flows on an every share basis. Cash EPS signifies only real earnings generated by the company, ignoring all the non-cash items that impact EPS.

Formula For Cash EPS = Operating Cash Flow/Number of outstanding shares

Importance of Earnings Per Share

  • EPS helps investors to find out, if investing in a company is profitable or not and that would help investors to generate more income by investing in it.
  • It also helps investors to compare the performance of peer companies to pick the most profitable investment option.
  • By using EPS investors calculate the Price-Earnings Ratio. In the Price-earning ratio formula (P/E Ratio), ‘E’ stands for EPS.
  • EPS also helps investors to measure a company’s financial standing by comparing its past performances.

Limitation of Earnings Per Share (EPS)

  • The companies can easily by buying back their own shares or with corporate reduction (Reverse splitting) of stocks to manipulate the EPS with reduced share to exaggerate their profitability.
  • EPS does not take into account the price of the stock so it fails to capture the performance of the company.

Conclusion

Earnings per share is an important fundamental analysis tool but works well with other important factors like Price-earnings Ratio, Price to book value ratio, Return on equity and more. So combined with those tools earnings per share gives a very good idea about the company for value investors.

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