Earnings per Share (EPS)
Earnings per Share (EPS)
The Earnings Per Share (EPS) financial measure captures the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share (EPS) serves as an indicator of a company's profitability.
Earnings per share is generally considered to be one of the most important factors of a share's price. It is also a major component used in the calculation of the price/earnings ratio.
How is earnings per share (EPS) calculated?
The major problem with calculating earnings per share (EPS) is what number of shares to use.
In the earnings per share (EPS) calculation, it is common practice to use a weighted average number of shares outstanding over the reporting term. That is because the number of shares outstanding can change over time.
In some cases, especially for the ease of calculation and a value availability, the calculation is occasionally simplified by using the number of shares outstanding at the end of the period.
Earnings per Share (EPS) = --------------------
Earnings per share (EPS) is a simple formula which makes this metric very popular.
For example, let's assume that a company has a net income of $50 million. If the company pays out $3 million in preferred dividends and has 20 million shares for half of the year and 15 million shares for the other half, then the earnings per share (EPS) would be $2.69 and would be calculated as follows:
Earnings $50 million - $3 million
per Share = -----------------------------------------------
(EPS) (20 million shares + 15 million shares) / 2
First, the $3 million is deducted from the net income to get $50 million, then a weighted average is taken to find the number of shares outstanding (0.5 x 20 million + 0.5 x 15 million = 17.5 million).
Limitations of earnings per share (EPS)
The capital that is required to generate the earnings (net income) if often ignored. In addition to looking at earnings per share (EPS), the cost of generating the earnings should be also considered.Two companies could generate the same earnings per share (EPS) number, but one could do so with less equity than the other one. The company with less equity would be more efficient at using its capital to generate income.
When comparing earnings per share (EPS) numbers, one should be rather conservative and suspicious. Earnings can be manipulated and will affect the quality of the earnings number.
It is important not to rely on a single financial measure but to use it in conjunction with statement analysis and other measures.