The earnings per share formula (EPS) is a measure of a company’s profitability. EPS is a financial indicator that shows how much profit a company has generated per one common stock.
This is one of the most popular indicators in the fundamental analysis, which is calculated by dividing the net profit of a given period by the number of issued common stocks. EPS should be thoroughly analysed before making a decision whether to buy shares of a given company. It provides important information for shareholders because it tells them how much profit their capital has generated.
Generally, the higher the earnings per share ratio, the higher the profits. It also means that the company has more resources that it can distribute among shareholders. Profit from the portfolio based on the companies with the highest EPS dynamics is often greater than the average.
The value of this indicator determines the company’s market position. Based on the EPS, we can quickly evaluate changes in the company’s profitability. These changes (e.g. increasing, decreasing or stable value) in longer periods allow us to predict the company’s future more accurate. However, the earnings per share ratio does not allow you to assess the company’s profitability, comparing it with the profitability of other companies, because the nominal values of shares of different companies are not equal. But despite these disadvantages, earnings per share ratio is very often used.
How to calculate earnings per share?
It can be calculated in different periods, although it is usually calculated every quarter based on quarterly reports of companies.
There are three ways to calculate the EPS:
- By dividing net income by weighted average common shares:
- By dividing the profit (excluding preferred dividends) by weighted average common shares:
- By dividing the income from continuing operations (excluding preferred dividends) by weighted average common shares:
The reason why preferred dividends are excluded in these formulas is preferred stocks higher ranking, i.e. preferred stocks are senior to common stock and, therefore, have a preference in dividend payments. Even though having preferred stocks doesn’t guarantee dividend payment, but the company must pay the stated dividend on preferred stock first and then on common stock (or at the same time).
Weighted average common shares, net income, profit, dividends on preferred stock can be found in the balance sheet and income statement.
The level of the EPS depends on many factors: number of shares, extraordinary profits and losses, financial charges, etc. Because the changes in any of these factors may be a one-time occurrence, it is better to compare EPS in time by creating a trend and to understand the factors affecting it.
Examples of earnings per share calculation
Example 1.
- ABC Company has net income of $100,000 during the year.
- There are no preferred shares, therefore, no preferred dividends.
- ABC had 10,000 weighted average shares outstanding during the year.
Earnings per share for ABC Company are:
EPS = \frac{ \$100,000 }{ 10,000 } = \$10Example 2.
- XYZ Company has net income of $10,000,000 during the year.
- XYZ had 100,000 weighted average shares and 5,000 preferred shares outstanding during the year.
- The dividends are $5 per share.
Diluted earnings per share
One of the earnings per share modifications is diluted earnings per share. Diluted EPS takes into account the effect of diluted securities like stock options, warrants, rights to purchase shares, convertible bonds and other securities, that can be transformed into common shares. In other words, diluted EPS shows the worst-case scenario when all the diluted securities will be exchanged to shares at once. Compared to EPS, diluted EPS always has a lower value. Diluted earnings per share can be calculated as:
Diluted\;EPS = \frac{ Profit = Preferred\; dividends }{ Weighted\; Average\;Common\;Shares + Diluted\;shares }