EPS stands for earnings per share. It is a financial ratio relating the earnings generated by the business to the number of shares in issue. The EPS refers to earnings generated during a specific time frame.
EPS is one of the most commonly used ways to gauge the profitability of a company. That’s because EPS growth can be a sign that a company is growing its profits.
Strong earnings tend to drive the price per share up, which is, of course, an attractive prospect for investors.
However, a rising EPS on its own does not guarantee a worthwhile investment. That’s because share buybacks will reduce shares in issue and boost the EPS.
Also, EPS does not consider debt.
The simplest way to calculate EPS is to divide the company’s profits by the number of outstanding company shares.
Basic EPS roughly measures the value of a company’s profit that can be allocated to one share of its common stock.
When calculating Basic EPS, the total of any preferred dividends must be removed from the net income as these are not available to common stockholders.
However, Basic EPS does not account for the way convertible securities dilute shares.
Therefore, there are more advanced calculations to consider. For instance, adjusting the numerator and denominator for shares that may be created through options, convertible debt, or warrants.
Diluted EPS is a more precise calculation because it considers outstanding securities such as stock options and convertible preferred shares.
The value of Diluted EPS is lower than Basic EPS because it considers a situation where convertible securities are exercised.
Companies with a more complex share structure must report both Basic EPS and Diluted EPS to give investors a clear picture of their profitability.
Using EPS to evaluate a company
When comparing two companies with identical EPS, it’s important to consider how much capital each company used to generate its profits. The one using less capital may operate more efficiently.
Companies often report EPS adjusted for extraordinary items and potential share dilution.
Where’s the value?
- Earnings per share (EPS) equates to a company’s net profit divided by the number of common shares outstanding.
- EPS is a commonly used financial metric for gauging value.
- Higher earnings per share indicate higher profits.
- EPS shows investors the amount of money a company makes for each share of its stock.
- There are various ways to calculate EPS. This depends on whether including or excluding extraordinary items or calculating basic EPS or diluted EPS.