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Earnings per share (EPS): Definition and meaning. Types, formulas and calculations for EPS
Confused by EPS figures in stock reports? You're not alone. The concept of Earnings Per Share can be baffling, leaving many investors in the dark about what these numbers really mean.
Find clarity and confidence in your investment strategy by exploring our straightforward, in-depth explanation of EPS.
Find clarity and confidence in your investment strategy by exploring our straightforward, in-depth explanation of EPS.
QUOTE
"If investing is entertaining, if you're having fun, you're probably not making any money. Good investing is boring."
Big ideas
- EPS, or Earning Per Share, is crucial in calculating the Price/Earnings (P/E) ratio, a key metric for assessing stock value relative to market expectations.
- Adjusting EPS to exclude extraordinary items offers a clearer view of ongoing profitability by removing one-off events, enabling consistent year-over-year comparisons.
- There are a few types of EPS. Basic EPS, for example, considers current outstanding shares only, whereas Diluted EPS includes all convertible securities, which can make it the better option for evaluating a company's financial health.
Earnings per share (EPS) is a key metric used by those working in the financial world to measure and compare company profitability.
Definition
Earnings Per Share, commonly known as EPS, is a key measure that quantifies the amount of a company's earnings distributed to each share of its common stock.
EPS offers a window into a company's financial performance, providing a snapshot of how much earnings are generated for each share held. While EPS is not the sole indicator of a company's health or stock potential, it's undoubtedly a significant piece of the puzzle to help you decide which shares to own and which to avoid.
Grasping the importance of EPS in financial analysis
EPS is particularly significant when making comparisons. When stock market investors are assessing the viability of investing in different companies, EPS acts as a common denominator, providing a level playing field for comparison, irrespective of the company size.
A higher EPS typically suggests a company is in a better profit-generating state, which can boost investor confidence and, consequently, the stock price. It is one of the two components used when calculating the Price-to-Earnings (P/E) ratio, another super-important metric when investing.
A lower EPS signifies a company that is going through a harder time generating profits, which raises doubts among investors as to whether it’s a temporary or a permanent shift towards weaker operating performance.
A higher EPS typically suggests a company is in a better profit-generating state, which can boost investor confidence and, consequently, the stock price. It is one of the two components used when calculating the Price-to-Earnings (P/E) ratio, another super-important metric when investing.
A lower EPS signifies a company that is going through a harder time generating profits, which raises doubts among investors as to whether it’s a temporary or a permanent shift towards weaker operating performance.
KEY TAKEAWAY
For the beginner investor, the top thing you can takeaway is to recognise that EPS is a reflection of a company's earnings efficiency - how effectively it turns revenues into profits. For example, if a company's EPS is increasing each year, it's likely becoming more profitable.
By analysing EPS trends, investors can gauge a company's growth trajectory, helping them make more informed decisions about their portfolio.
Types of EPS
1. Basic EPS
This is calculated by dividing a company's net income by the total number of outstanding shares. It provides a direct measure of profitability on a per-share basis, making it easier for shareholders to understand their earnings from each share owned.
2. Diluted EPS
This expands on the Basic EPS by considering potential shares that could be created through convertible securities like options or warrants. This gives a more conservative estimate of EPS, assuming all these convertibles were exercised.
3. Trailing EPS
This refers to the EPS calculated using the net income of the past 12 months. It's a backwards-looking measure that provides investors with an idea of a company's recent earnings performance.
4. Current EPS
This refers to the EPS calculated using the net income of the past 12 months. It's a backwards-looking measure that provides investors with an idea of a company's recent earnings performance.
4. Forward EPS
This is a forward-looking measure, projecting future earnings. Analysts estimate Forward EPS based on expected future earnings and the number of outstanding shares. This is based on estimates and is subject to revisions.
Formula and calculation for EPS
Formula for basic EPS
FORMULA
Basic EPS = Net income - Preferred Dividends / Total number of outstanding shares
This calculation provides a direct measure of how much earnings a company generates per share of its common stock. Only dividends on preferred shares are subtracted, not those on common shares, so that it gives a clear picture of the profitability available to common shareholders.
Formula for diluted EPS
FORMULA
Diluted EPS = (Net income - Preferred Shares) / (Total no. outstanding shares + Potential Shares from Convertibles)
In this equation, 'Potential Shares from Convertibles' refers to additional shares that would be in circulation if all convertible bonds, stock options, warrants, etc., were converted to common stock.
For your convenience, you can find in-depth data for each stock in the Trading 212 app. Just choose a company, scroll down to Key ratios, tap More ratios>Per share data, and you will find the exact basic EPS (excluding extraordinary items) and diluted EPS (including extraordinary items):
For your convenience, you can find in-depth data for each stock in the Trading 212 app. Just choose a company, scroll down to Key ratios, tap More ratios>Per share data, and you will find the exact basic EPS (excluding extraordinary items) and diluted EPS (including extraordinary items):
Unravelling the difference between basic EPS and diluted EPS
Definition of basic EPS and diluted EPS
Basic EPS calculates a company's earnings divided by the total number of outstanding shares, offering a direct view of profitability per share. In contrast, Diluted EPS goes a step further by including all convertible securities, like options and warrants, in the total share count.
Calculation differences between basic EPS and diluted EPS
The primary difference in calculating Basic and Diluted EPS lies in the denominator of their respective formulas. Basic EPS uses the current number of outstanding shares, while Diluted EPS expands this number to include all possible shares that could exist if convertible securities were exercised.
To illustrate how EPS is calculated, let’s look at a hypothetical example.
Basic EPS EXAMPLE
Imagine a company called "Expedited Parcel Services Ltd" which has reported a net income of £50 million for the fiscal year. The company has 10 million common shares outstanding and has issued £2 million in dividends on its preferred stock.
To calculate the Basic EPS for Expedited Parcel Services Ltd, we would use the formula for Basic EPS:
Basic EPS = Net Income - Preferred Dividends / Total Outstanding Shares
Substituting the values, we get:
Basic EPS = (£50 million - £2 million) / 10 million = £48 million / 10 million = £4.80
This means that for every common share, the company has earned £4.80 in profits over the fiscal year.
To calculate the Basic EPS for Expedited Parcel Services Ltd, we would use the formula for Basic EPS:
Basic EPS = Net Income - Preferred Dividends / Total Outstanding Shares
Substituting the values, we get:
Basic EPS = (£50 million - £2 million) / 10 million = £48 million / 10 million = £4.80
This means that for every common share, the company has earned £4.80 in profits over the fiscal year.
Diluted EPS EXAMPLE
Now, if we consider that Expedited Parcel Services Ltd also has options and warrants, which could potentially convert into 1 million additional shares, we need to calculate the Diluted EPS.
Using the formula for Diluted EPS:
Diluted EPS = £48 million / (10 million + 1 million) = £48 million / 11 million = £4.36
The Diluted EPS, considering the potential dilution from convertible securities, would be £4.36, offering a more conservative view of the company’s earnings per share.
Using the formula for Diluted EPS:
Diluted EPS = £48 million / (10 million + 1 million) = £48 million / 11 million = £4.36
The Diluted EPS, considering the potential dilution from convertible securities, would be £4.36, offering a more conservative view of the company’s earnings per share.
How is EPS used?
Use by investors and analysts
EPS helps in making informed comparisons between different companies within the same industry or sector, regardless of their size.
Investors often look at EPS trends over time to assess a company's growth trajectory. Many investors will use the EPS as part of a stock filter to aid in identifying stocks that may offer value or growth potential.
Investors often look at EPS trends over time to assess a company's growth trajectory. Many investors will use the EPS as part of a stock filter to aid in identifying stocks that may offer value or growth potential.
A variable in the price/earnings ratio
The P/E ratio is many investors’ number 1 metric in stock valuation. It compares a company's share price to its earnings via EPS. This ratio helps investors gauge market expectations and determine whether a stock is fairly valued, overvalued, or undervalued.
The best bargains in the shop are good products with low prices. Intuitively, the best companies to invest in are those that have high earnings and a low price, this translates to a low P/E ratio.
The best bargains in the shop are good products with low prices. Intuitively, the best companies to invest in are those that have high earnings and a low price, this translates to a low P/E ratio.
EPS excluding extraordinary items
Many companies report this figure ahead of the basic EPS and so it's important to know what it is that’s ‘extraordinary’ that’s being left out.
Definition of EPS excluding extraordinary items
EPS excluding extraordinary items removes one-time events from a company's earnings calculation.
Extraordinary items can include:
- Unusual expenses
- Revenues or losses not related to the regular business operations
- Profits from asset sales
- Costs from restructuring
- Litigation expenses
Extraordinary items can include:
- Unusual expenses
- Revenues or losses not related to the regular business operations
- Profits from asset sales
- Costs from restructuring
- Litigation expenses
By excluding these items, this adjusted EPS provides a clearer view of a company's regular, ongoing profitability, making it easier for investors to assess its true earnings performance.
Formula for EPS excluding extraordinary items
Adjusted EPS = (Net Income - Preferred Dividends - Extraordinary Items) / Total Outstanding Shares
This equation subtracts any extraordinary items from the net income before dividing by the total number of outstanding shares.
How EPS and capital relate?
The number of outstanding shares, a key component in EPS calculation, is directly affected by the company's capital decisions, such as issuing new stock or buying back shares. Such activities can lead to changes in the share count, thereby impacting EPS.
Impact of stock buybacks and stock splits on EPS
Stock buybacks and stock splits are two capital events with significant implications for EPS:
- Buybacks reduce the number of outstanding shares, often leading to an increase in EPS, as the same amount of earnings is distributed over fewer shares.
- Stock splits increase the number of shares, which can dilute EPS if the earnings remain constant.
These actions demonstrate how capital management strategies can directly influence a company's EPS, reflecting its financial manoeuvring.
What is a good EPS when making an investment?
Factors to consider when evaluating EPS
A high EPS is generally speaking ‘good’ but determining what exact number constitutes a good EPS for a particular company involves finding comparable peers as well as considering the business and economic environment. Naturally, earnings will tend to be lower in a weak economy, so you must lower the bar for what constitutes good.
Here are 4 ways to find comparable peers:
Here are 4 ways to find comparable peers:
Identifying Comparable Peers
1. Revenue: Higher revenue companies often have different EPS benchmarks than smaller firms, as larger revenues can lead to higher profitability and, thus, a potentially higher EPS.
2. Market Capitalization: Large-cap companies generally have more stable but lower EPS due to more shares outstanding, while small-cap firms might show higher EPS but with more volatility.
3. Geographic Region: EPS benchmarks vary by region, with differences influenced by economic conditions, market maturity, and industry dominance in each geographic area.
4. Industry Classification: Different industries have varying average EPS, influenced by factors like growth potential, regulatory environment, and capital intensity.
2. Market Capitalization: Large-cap companies generally have more stable but lower EPS due to more shares outstanding, while small-cap firms might show higher EPS but with more volatility.
3. Geographic Region: EPS benchmarks vary by region, with differences influenced by economic conditions, market maturity, and industry dominance in each geographic area.
4. Industry Classification: Different industries have varying average EPS, influenced by factors like growth potential, regulatory environment, and capital intensity.
Industry benchmarks for EPS
Industry benchmarks provide a useful context for assessing EPS. Additionally, the growth trajectory of EPS over time is often more telling than a single EPS figure.
The following chart shows what were the expected EPS growth figures per sector and for the S&P 500 index for 2023:
The following chart shows what were the expected EPS growth figures per sector and for the S&P 500 index for 2023:
Forecasted EPS growth in 2023 by sector
Usually, technology companies might have higher EPS due to rapid growth and scalability, while more stable industries like utilities may exhibit lower EPS. It’s also helpful to look at historical industry benchmarks to understand how EPS fluctuates over time within a specific sector.
What is the difference between EPS and adjusted EPS?
Definition of EPS and adjusted EPS
Earnings per share is a measure of a company's profit allocated to each outstanding share of common stock. Adjusted EPS, on the other hand, refines this calculation by excluding certain items that are not considered part of regular business operations.
Calculation differences between EPS and adjusted EPS
While traditional EPS calculations include all income and expenses reported in a given period, Adjusted EPS specifically excludes non-recurring items.
You should know the limitations of EPS
Other metrics to consider alongside EPS
While EPS is a valuable tool in financial analysis, it's not without limitations. EPS does not account for the capital required to generate earnings, nor does it reflect a company's cash position. To get your head fully around the performance of a company and how it might change in the future, you need to use a variety of financial indicators.
Cash flow, revenue growth, debt levels, and return on equity provide additional insights into a company's financial health and future prospects.
Cash flow, revenue growth, debt levels, and return on equity provide additional insights into a company's financial health and future prospects.
Recap
Earnings per share reflect the company's profitability. It's calculated by dividing the firm's net income by the number of outstanding shares. It's used as a crucial indicator, showcasing a company's ability to generate profits, evaluating performance and comparing it within its industry or over time.
EPS also influences stock prices, often being a key factor in investment decisions and market valuations.
EPS also influences stock prices, often being a key factor in investment decisions and market valuations.
FAQ
Q: How does EPS impact a company's stock price?
EPS impacts a company's stock price as it is a primary indicator of financial performance. Higher EPS often suggests stronger profitability, potentially leading to increased investor confidence and higher stock prices.
Conversely, lower EPS may signal financial challenges, possibly resulting in a decrease in stock price. However, EPS should be considered alongside other factors, as it is not the sole determinant of stock price movements.
Conversely, lower EPS may signal financial challenges, possibly resulting in a decrease in stock price. However, EPS should be considered alongside other factors, as it is not the sole determinant of stock price movements.
Q: How does EPS relate to dividends and capital, and what is the impact of stock buybacks and stock splits on EPS?
EPS relates to dividends and capital as it is calculated after accounting for preferred dividends and is influenced by the number of outstanding shares, which can be affected by capital strategies like stock buybacks and splits.
Stock buybacks typically increase EPS by reducing the number of shares outstanding, while stock splits increase the number of shares, potentially diluting EPS if earnings remain constant.
Stock buybacks typically increase EPS by reducing the number of shares outstanding, while stock splits increase the number of shares, potentially diluting EPS if earnings remain constant.
Q: What are some limitations of using EPS as a metric?
Limitations of using EPS include its inability to account for the company's capital structure or cash position, and it does not consider the quality of earnings (i.e., whether they are sustainable or a result of one-time events).
EPS can be misleading if used in isolation without other financial metrics and does not necessarily reflect the company's overall financial health.
EPS can be misleading if used in isolation without other financial metrics and does not necessarily reflect the company's overall financial health.
Q: How does EPS impact a company's dividend policy?
EPS can impact a company's dividend policy as it reflects the company's profitability, which is a key factor in determining its ability to pay dividends.
Generally, higher and stable EPS may indicate more capacity for consistent dividend payments, whereas lower or volatile EPS might lead to less predictable dividend policies.
Generally, higher and stable EPS may indicate more capacity for consistent dividend payments, whereas lower or volatile EPS might lead to less predictable dividend policies.
Q: What is the significance of EPS for investors and analysts?
For investors and analysts, EPS is a significant metric as it provides a quick snapshot of a company's profitability on a per-share basis, aiding in the evaluation of its financial health and growth potential.
It is also a key component in valuation models, like the P/E ratio, helping in comparing companies within the same industry.
It is also a key component in valuation models, like the P/E ratio, helping in comparing companies within the same industry.
