Earnings per share (EPS) is a financial ratio. It divides a company’s net profit by the number of outstanding common shares.
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What’s earning per share (EPS), and why’s it important?
Earnings per share (EPS) is an important financial measurement that divides a company’s net profit by the number of outstanding shares of common stock.
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The result indicates the profitability of a company. The higher the value, the more profitable the company is, and vice versa. EPS is often calculated quarterly or annually.
Although EPS isn’t the only tool and calculation to determine the profitability, health, and value of a business, it’s an effective one that’s widely used.
When you’re calculating EPS, it’s important to compare several companies within the same industry.
By comparing the EPS of several companies, you can make a good decision about which one to invest in.
There are several methods to calculate EPS. The most common method is to divide a company’s net income by the number of outstanding shares.
If a company pays dividends, you must subtract the total from the net income before dividing it by the number of outstanding shares.
Before you do the calculation, there are two ways to figure out how many outstanding shares there are. They’re as follows:
- End-of-period shares outstanding.
- Weighted average shares outstanding.
Since the number of shares can change, it’s best to use the weighted average shares outstanding.
The following is the formula to calculate basic EPS:
EPS = (Net income – Preferred dividends) / Weighted average shares outstanding or end-of-period shares outstanding.
Diluted EPS is another type of calculation that’s used because basic EPS overlooks dilutive securities, such as stock options, warrants, and convertible bonds.
The following is the formula to calculate diluted EPS:
Diluted EPS = (Net income – Preferred dividends) / (Weighted average shares outstanding + Stock options + Warrants + Convertible bonds + other dilutive securities).
Dilutive securities increase the number of outstanding shares without increasing the net income.
Learning how to calculate EPS makes you a more informed investor. Understanding how companies stack up will help you make a better decision.
Now that you know how EPS is calculated, how does it look in the real world?
For example, Company A has a net income of $400 million, pays $10 million in dividends, and has 100 million outstanding shares in the first half of the quarter. In the second half of the quarter Company A had 200 million outstanding shares, which results in an average of 150 million outstanding shares in the quarter.
The first step is to subtract $10 million from $400 million, which is $390 million. Then, you’ll divide $390 million by 150 million outstanding shares, which is 2.6. That means Company A’s earnings per share is $2.60.
With the earnings, a company can invest back into the company or pay dividends to its shareholders.
Earnings per share is a significant financial measurement because it can affect stock prices and it tells you the profitability of a company. Calculating EPS helps you make informed decisions with your investments.
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About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.