Looking to start your investment journey but feeling overwhelmed by all the financial jargon? Don’t worry, the earnings per share formula is a vital concept that you need to understand to make informed investment decisions.
Earnings per share formula measure how profitable a company is for every share outstanding of its common stock. EPS is used by companies to determine their profitability and to compare them to competitors.
Investors often look at EPS to determine whether a company is able to generate earnings and how well it is performing financially. Also, EPS is used as a metric for valuing a company, since higher EPS indicates a higher earning potential.
The earnings per share formula is a commonly used metric to evaluate the financial performance of a company.
The earnings per share formula is significant for several reasons:
- Evaluating company performance
- Comparing companies
- Evaluating stock price
- Making investment decisions
What Are Earnings Per Share?
EPS is commonly used by investors and analysts to evaluate a company’s financial health and make informed investment decisions. A higher EPS indicates greater profitability and attractiveness to investors, potentially leading to a rise in stock price.
It also enables progress tracking and facilitates comparisons of profitability between companies in the same industry, identifying outperformers and underperformers.
What Is The Earnings Per Share Formula?
The formula for calculating Earnings Per Share is a widely used metric in finance and accounting.
The EPS is calculated by dividing the net income of a company, after deducting any preferred dividends, by the number of outstanding shares of common stock.
How To Calculate EPS?
To calculate earnings per share, you must first determine the company’s me. This is done by subtracting the company’s total expenses from its total revenues, taking into account all costs associated with running the business.
Next, you must subtract the company’s preferred dividends from the calculated net income.
Preferred dividends are a type of dividend paid to preferred stockholders, and they must be taken into consideration when determining the net income available to common stockholders
Outstanding shares of common stock, as the name suggests, are the total number of shares of common stock that have been issued and are currently held by investors.
Finally, divide the resulting number by the company’s outstanding shares of common stock. The resulting number is the company’s EPS which could mathematically be expressed as shown in the picture below:
Earnings Per Share Formula – Earnings Per Share Calculator:
There are a number of online tools available that make it easy to calculate earnings per share.
These tools typically require the user to enter three pieces of information: the company’s net income, preferred dividends, and the number of outstanding shares of common stock.
The tool will then use this information to perform the calculation and generate the company’s EPS.
The benefits of using online tools such as earnings per share calculators include their ease of use and accessibility.
Users can simply enter the necessary information and quickly obtain the results, without needing to perform manual calculations or have a deep understanding of financial metrics.
Additionally, many online EPS calculators provide additional resources and information that can help users better understand the financial performance of a company and how EPS fits into the bigger picture.
Basic Earnings Per Share Calculation Example:
Let’s look at an example of how to calculate earnings per share.
Assume a company has a net income of $1 million, preferred dividends of $200,000, and 1 million outstanding shares of common stock. The company’s EPS would be:
EPS = ($1 million – $200,000) / 1 million = $0.80
In this example, the company’s EPS is $0.80.
Effect of Stock Dividends & Stock Splits on EPS:
Stock dividends and stock splits are methods for distributing a company’s profits and assets to its shareholders.
A stock dividend involves issuing additional shares to shareholders, while a stock split involves splitting existing shares into multiple shares.
Both actions result in an increase in the number of outstanding shares and a corresponding reduction in EPS.
These events can influence how a company’s overall earnings are perceived by investors and analysts, but they do not necessarily impact the company’s actual earnings.
For example, Apple Inc. has a trailing 12-month net income of $95.171 billion and had 15.943 billion outstanding shares of common stock in Sep 2022. The initial EPS for the period was:
If Apple had declared a stock dividend of 4% to its shareholders, this meant that for every 100 shares of Apple stock, investors would receive 4 additional shares.
As a result, the number of outstanding shares increased to 16.580 billion, and the EPS decreased to $95.171 billion / 16.580 billion = $5.73 per share.
The decrease in EPS is due to the dilution of earnings per share caused by the increase in the number of outstanding shares.
When a company conducts a stock split, it increases the number of outstanding shares by issuing additional shares to existing shareholders.
For example, in a 2-for-1 stock split, a shareholder who previously held 100 shares would now hold 200 shares, with each share being worth half as much as the original shares.
Since the number of shares outstanding has increased but the company’s net income remains the same, the EPS will be reduced by the same factor as the stock split. In the example above, the EPS would be halved as a result of the 2-for-1 split.
Let’s suppose, Apple announced a 4-for-1 stock split, which meant that for every 1 share of Apple stock, investors received 3 additional shares.
As a result, the number of outstanding shares increased to 63.772 billion, while the price per share decreased.
Despite the increase in the number of outstanding shares, the EPS remained unchanged at $95.171 billion / 63.772 billion = $1.49 per share, which is one-fourth of $5.96 of EPS before the split.
However, it’s important to note that the reduction in EPS is purely a mathematical effect of the stock split and does not reflect a change in the company’s underlying financial performance.
The value of the company and the amount of its profits remain unchanged by the stock split. This example illustrates that stock dividends can decrease the EPS, while stock splits do not have any effect on the EPS.
How Are EPS Used?
EPS is not only used to measure a company’s progress over time but also plays a crucial role in determining the value of a company’s stock.
If a company reports higher-than-expected EPS, its stock price is likely to go up, as investors view this as a positive sign of the company’s financial health and strong earning power.
On the other hand, if a company’s EPS falls below expectations, its stock price may decline, as investors may interpret this as a sign of financial weakness.
Basic EPS vs. Diluted EPS
There are two types of earnings per share: basic EPS and diluted EPS.
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Basic EPS
Basic EPS is a simple and straightforward measure of per share earnings, diluted EPS is a more precise and comprehensive measure that considers the impact of convertible securities on earnings.
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Calculating Basic EPS
Basic earnings per share calculation have been done by dividing a company’s net earnings by the number of outstanding shares of its common stock.
It is a simple calculation that provides a rough estimate of a company’s EPS. However, it does not take into account the impact of convertible securities on EPS. -
Diluted EPS
Diluted EPS, on the other hand, is a more precise measure of a company’s earnings. It takes into account the potential dilution that could occur if all convertible securities, such as options and warrants, were converted into common stock.
For example, if a company has outstanding options and warrants that allow the holders to purchase additional shares of common stock, the number of outstanding shares will increase if these options and warrants are exercised.
This will result in a dilution of EPS because the net earnings will be spread over a larger number of shares. By taking this potential dilution into account, diluted EPS provides a more accurate picture of a company’s earnings.
For this reason, diluted EPS is often considered to be a more accurate measure of a company’s profitability, and it is the preferred measure of earnings for many investors and analysts.
The Significance of Earnings Per Share:
The significance of EPS is that it provides a standard way of comparing the profitability of different companies, regardless of the number of shares they have outstanding.
It gives investors a clear and concise picture of how much money they would make if they owned a single share of the company’s stock.
Higher EPS values are generally considered a good sign, as they indicate that a company is earning more money and is likely to pay out dividends in the future.
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Accurate evaluation of their financial performance
Comparing companies’ EPS allows for an accurate evaluation of their financial performance and ability to remain competitive in the industry.
For instance, if Company A’s EPS is $1 and Company B’s EPS is $2, then Company B is likely to have better financial performance and remain more competitive in the industry. -
The Importance of Understanding EPS in Making Sound Investment Decisions
Understanding the EPS of companies in the same industry is key to making sound investment decisions that may yield a profitable return.
For instance, if two companies in the same industry have similar revenue but one has a significantly higher EPS, the company with the higher EPS is likely to be more profitable and a better investment. -
Analyzing EPS: How It Helps Investors Determine Viable Investment Options
By analyzing a company’s EPS, investors are better equipped to determine if the company is a viable option for their portfolio, and ultimately determine if an investment in that company will generate a beneficial return.
For example, if a company is reporting high quarterly earnings but its EPS is decreasing, it could be a sign that the stock is overvalued and investors should consider other options.
What Is a Good EPS?
Determining what constitutes a “good” EPS is a complex task, as it depends on various factors such as the company’s industry, size, and financial history. It’s essential to understand that the definition of a good EPS varies greatly depending on the context.
In general, a higher EPS is considered to be a positive indicator of the company’s financial performance, as it suggests increased profitability. However, this metric alone is not sufficient to evaluate the overall financial health of the company. It’s critical to look at other crucial indicators such as revenue growth, operating margins, and debt-to-equity ratio to obtain a complete picture of the company’s financial stability.
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Factors Impacting EPS
It’s also important to remember that EPS can be influenced by various non-operational factors, such as share buybacks or dilution from the issuance of new shares.
Hence, it’s always recommended to examine EPS in conjunction with other financial metrics and to keep in mind the context in which it’s being evaluated.
How Do EPS Affect Stock Valuation?
Earnings per share (EPS) play a crucial role in determining a company’s stock valuation and market performance. A positive EPS figure that exceeds expectations can result in a significant boost in the stock price, as it is seen as a sign of a healthy, growing business.
On the other hand, a lower-than-expected EPS figure can trigger a decline in the stock price, as it suggests a decrease in profitability and can raise concerns about the company’s future performance.
Conclusion
EPS is a financial indicator that measures a company’s profitability by dividing its net income by the number of outstanding shares. It’s crucial to consider external factors like dividends and stock splits.
If a company’s EPS exceeds market expectations, its stock price may rise; if it falls short, the price may decline. And, understanding the earnings per share formula is valuable to investors and analysts in making informed decisions about which stocks to buy or sell.
FAQs
How Do You Analyze EPS Ratio?
What Factors Impact EPS?
• Changes in interest rates
• Foreign currency exchange rates
• Overall economic environment
• Stock buybacks
• Dilutive stock issuance
