Do you want to know how profitable a company is? You can always analyse it through Earnings Per Share (EPS). This powerful metric divides a company’s profit by the number of outstanding shares, giving you easy-to-understand details of a company’s earning power.
EPS is a prime indicator of a company’s financial health and is closely watched by investors, analysts, and financial professionals. It is also a key component of many stock valuation models.
Whether you are an experienced investor or just getting started, understanding EPS is a must-have skill. This article made it simple for you with a detailed yet simple explanation.
What are Earnings Per Share (EPS)?
Earnings Per Share (EPS) is a financial ratio that shows how much profit a company has generated per share of stock. It is measured by dividing the total number of outstanding shares of common stock by the net income of the business.
It is an important metric for investors, analysts and financial professionals to evaluate a company’s performance and make investment decisions.
EPS is also used in many stock valuation models, such as the P/E ratio (price-to-earnings ratio), which compares a company’s stock price to its EPS.
It is also used to compare the profitability of a company over time or against other firms in the same industry.
Types of EPS
There are five different ways to measure a company’s earnings per share (EPS), and each provides a different perspective on the company’s financial performance. They are as follows:
Ongoing EPS or Pro Forma EPS:
It is also known as Pro forma EPS, calculated based on the regular net income and typically excludes any unusual or one-time events. This variation of EPS aims to predict income from core business operations, but it does not provide a complete picture of the company’s actual earnings.
It’s worth noting that this variation of EPS is based on certain assumptions, and certain income or expenses used to calculate reported earnings may be excluded from this EPS calculation. The word “pro forma” implies that certain assumptions were made during the computation.
Reported EPS or GAAP EPS:
This EPS is calculated using the Generally Accepted Accounting Principles and is reported in the company’s SEC filings. However, it’s worth noting that using GAAP can sometimes alter a company’s earnings.
For example, if a company records income generated from a one-time payment as operating income according to GAAP, it inflates the EPS. Similarly, if a business classifies regular expenses as unusual, it would artificially increase the EPS.
Retained EPS:
Retained earnings per share (EPS) refers to the profit a company keeps instead of distributing it to shareholders as dividends. Business owners may use retained EPS to repay debts for expansion or save for future needs.
To calculate retained EPS, net earnings are added to current retained earnings, and the total dividends paid are subtracted. The result is divided by the number of outstanding shares.
Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares.
Cash EPS:
Cash EPS provides insight into a company’s financial position by showing the actual cash earned by the company. As it is difficult to manipulate, it is a reliable measure of a company’s financial health.
It is calculated by the following formula,
Cash EPS = Operating Cash Flow / Diluted Shares Outstanding
Book Value EPS:
This EPS variation, known as equity per share, allows individuals to determine the total amount of a company’s equity in each share.
It is also useful for estimating the value of a company’s shares in the event of liquidation. Typically, it is considered a snapshot of a company’s performance as it primarily focuses on the balance sheet.
Formula and Calculation for Earnings Per Share
The calculation for EPS is as follows:
EPS = (Net Income – Preferred Stock Dividends) / Outstanding Common Shares
where,
Net Income: This is the profit a company has earned during a given period. It is shown on the income statement for the company.
Dividends on Preferred Stock: This is the money paid to preferred stockholders during the same period. This can be found on the cash flow statement for the company.
Average Outstanding Shares: This is the average number of shares of common stock a company has issued over a specific period. This is shown on the balance sheet of the business. It is important to note that there are different variations of EPS depending on the calculation.
Basic EPS is calculated by dividing the company’s net income by the number of outstanding shares of common stock.
Diluted EPS takes into account the potential dilution of a company’s earnings, such as the conversion of convertible securities, and is calculated by dividing the company’s net income by the number of shares that would be outstanding if all dilutive securities were exercised.
Example of EPS
Let’s say a company has a net income of Rs. 5,000,000, pays Rs. 500,000 in preferred stock dividends, and has an average of 100,000 outstanding shares.
To calculate EPS in this case:
EPS = (Rs. 5,000,000 – Rs. 500,000) / 100,000 = Rs. 40 per share
So, the EPS of the company is Rs. 40 per share.
Another example,
If a company has a net income of Rs. 20,000,000, pays Rs. 1,000,000 in preferred stock dividends and has an average of 2,000,000 outstanding shares.
To calculate EPS in this case:
EPS = (Rs. 20,000,000 – Rs. 1,000,000) / 2,000,000 = Rs. 9 per share
So, the EPS of the company is Rs. 9 per share.
What is the use of EPS?
The main use of EPS (Earnings Per Share) is to measure the profitability of a company. It is a financial ratio that expresses the net income earned per outstanding share of common stock. EPS is used by investors, analysts, and other stakeholders to assess the performance of a company.
There are several ways EPS can be used:
Comparison: EPS can be used to compare the profitability of different companies in the same industry.
Valuation: EPS can be used to value a company by comparing its EPS to that of similar companies or its historical EPS.
Investment Decisions: Investors can use EPS to help make investment decisions. A company with a high EPS may be more profitable and, therefore, a better investment than a company with a low EPS.
Dividend Payout: EPS calculates the dividend payout to the shareholders. EPS determines the amount of money that can be distributed to the shareholders as dividends.
Credit Worthiness: EPS can be used as one of the indicators of a company’s creditworthiness. A company with a high and consistent EPS is considered more creditworthy than a company with a low and inconsistent EPS.
EPS is a widely used financial ratio and is considered one of the important financial metrics used by investors and analysts to evaluate the performance of a company.
Basic EPS vs. Diluted EPS
Basic EPS and Diluted EPS are two different measures of a company’s profitability per share. Both are calculated by dividing the company’s net income by the number of outstanding shares, but they differ in the number of shares used in the calculation.
Below is a table that compares the key aspects of Basic EPS and Diluted EPS:
Basic EPS | Diluted EPS |
Basic EPS is calculated by dividing the company’s net income by the number of outstanding shares. It is also known as “primary earnings per share” | Diluted EPS is calculated by adjusting the number of outstanding shares to include the dilutive effect of outstanding stock options, warrants, and convertible securities. It is also known as “fully diluted earnings per share” |
It is calculated using the number of shares outstanding at the end of the period. | It is calculated using the number of shares outstanding at the end of the period, including any shares that would be issued upon the exercise of outstanding options, warrants, and convertible securities. |
It measures a company’s profitability on a per-share basis for the current shareholders. | It is a measure of a company’s profitability on a per-share basis for both current shareholders and potential shareholders who hold outstanding options, warrants, and convertible securities. |
It is generally considered to be a more conservative measure of a company’s profitability. | It is generally considered to be a more realistic measure of a company’s profitability, as it takes into account the potential dilution of earnings that may occur in the future. |
Excluding Extraordinary Items - EPS
EPS excluding extraordinary items is a measure of a company’s profitability that excludes any non-recurring or infrequent items that may have a significant impact on the company’s overall earnings per share (EPS) for a specific period.
These items may include things like the gain or loss from the sale of a significant asset, a natural disaster, or a major litigation settlement.
By excluding these items, analysts and investors are able to get a more accurate picture of the company’s underlying performance and growth potential.
Formula for EPS Excluding Extraordinary Items:
The formula for EPS excluding extraordinary items is similar to the standard formula for EPS, which is net income divided by the number of outstanding shares.
The key difference is that it excludes any non-recurring or infrequent items that may have a significant impact on the company’s overall earnings per share (EPS) for a specific period.
The formula can be represented as:
EPS excluding extraordinary items = (Net income – Extraordinary items) / Number of outstanding shares
This formula helps to provide a more accurate picture of the company’s underlying performance and growth potential by excluding the impact of any non-recurring or infrequent items that may have a significant impact on the company’s overall EPS for a specific period.
Continuing Operations EPS
Continuing operations EPS is a measure of a company’s profitability that excludes any income or loss from discontinued operations. Discontinued operations refer to a component of a company that has been sold, disposed of, or is held for sale.
This includes the income or loss from the operations of the discontinued component, any gain or loss from the disposal of the component, and any related income tax effects.
The formula for continuing operations EPS is similar to the standard formula for EPS, which is net income divided by the number of outstanding shares. The key difference is that it excludes any income or loss from discontinued operations.
The below formula is used,
Continuing operations EPS = (Net income from continuing operations – Income tax effects) / Number of outstanding shares
EPS vs.Capital vs. Dividends vs.Price-to-Earnings (P/E)
PS (Earnings per share) and Capital are two important financial measures used to evaluate a company’s performance and growth potential.
Below is a table that compares the key aspects of EPS and Capital:
EPS | Capital | Dividends | Price-to-Earnings (P/E) |
EPS is a measure of a company’s profitability, calculated by dividing the company’s net income by the number of outstanding shares. It represents the amount of profit earned per share of stock. | Capital refers to the total amount of money that a company has raised from investors, including shareholders and debt holders. This includes both long-term and short-term debt, as well as equity capital. | Dividends are a portion of a company’s profits that is distributed to shareholders as a payment. It is usually paid out on a quarterly basis. | P/E ratio is a valuation ratio calculated by dividing the current market price of a stock by its EPS. It measures the price an investor is willing to pay for each dollar of earnings. |
It is used by investors and analysts to evaluate a company’s financial performance and compare it to other companies in the same industry. | It is used by investors and analysts to evaluate a company’s financial strength and its ability to meet its financial obligations and grow its business. | It is used by investors as a way to receive a return on their investment. They are also used by companies as a way to retain and attract investors. | It is used by investors and analysts to evaluate a company’s stock price relative to its earnings and compare it to other companies in the same industry. |
It can be affected by factors such as revenue growth, expenses, and taxes. | It can be affected by factors such as debt and equity issuance, cash flow, and dividend payouts. | It is affected by a company’s profitability, cash flow, and growth potential. Companies with strong earnings and cash flow are more likely to pay dividends than those that are struggling financially. | It is affected by the market’s perception of a company’s growth potential, risk and profitability. A higher P/E ratio means the market is willing to pay more for each dollar of earnings and implies higher growth expectations. A lower P/E ratio means the market is willing to pay less for each dollar of earnings and implies lower growth expectations. |
It is generally considered to be a positive indicator of a company’s financial health and future growth potential. | Capital structure is generally considered to be a positive indicator of a company’s long-term financial stability. | They are generally considered to be a positive indicator of a company’s financial stability and ability to generate consistent profits. High dividends can also act as a signal of a company’s confidence in its future growth prospects. | It is generally considered to be a positive indicator of a company’s future growth prospects. However, it’s important to compare P/E ratios within the same industry to get a better understanding of a company’s relative value. |
What is a Good EPS?
The question of what constitutes a “good” EPS depends on several factors, including the company’s industry, size, and growth prospects.
However, in general, a higher EPS is generally considered to be a positive indicator of a company’s financial health and future growth potential.
Here are a few things to consider when evaluating a company’s EPS:
EPS Growth:
A company’s EPS should be growing over time, as this indicates that the company is increasing its profitability. A company’s EPS growth rate should be compared to its industry peers and to the overall market.
EPS Compared to Industry Peers:
EPS should be compared to other companies in the same industry to get a better understanding of a company’s relative performance. A company with a higher EPS than its peers may be considered to be performing better financially.
EPS Compared to Historical Levels:
A company’s EPS should be compared to its own historical levels to get a better understanding of its performance over time. A company that has consistently high EPS is generally considered to be in a good financial position.
EPS Compared to the Market:
EPS should also be compared to the overall market, as a company with a high EPS may be considered to be performing well even if it has a lower EPS than its peers.
EPS Relative to P/E Ratio:
P/E ratio is a measure of how much investors are willing to pay for each dollar of earnings. A company with a high P/E ratio and high EPS may be considered to have a high growth potential.
What is the Difference Between EPS and Adjusted EPS?
EPS (Earnings Per Share) | Adjusted EPS |
It represents the portion of a company’s profit allocated to each outstanding share of common stock. | It is a modified version of EPS that excludes certain items such as one-time charges or gains. |
It is calculated by dividing net income by the number of outstanding shares. | It is calculated by adjusting net income for certain items and then dividing it by the number of outstanding shares. |
It is used to evaluate a company’s profitability. | It is used to evaluate a company’s profitability while excluding the impact of certain non-recurring items. |
It provides a standard way to compare a company’s earnings to that of its peers. | It provides a more accurate picture of a company’s underlying earnings performance. |
What Are Some Limitations of EPS?
The following are some of the limitations of EPS that should be considered:
Earnings Manipulation:
EPS can be manipulated through accounting techniques such as aggressive cost-cutting or deferring expenses. This can lead to a higher EPS but may not reflect the true underlying performance of the company.
One-Time Events:
EPS does not consider one-time events such as acquisitions, divestitures, or other non-recurring items. These events can significantly impact a company’s EPS but may not be indicative of its long-term performance.
Capital Structure:
EPS does not consider a company’s capital structure, such as the number of outstanding shares or the use of debt financing. This can make it difficult to compare the EPS of companies with different capital structures.
Limited Perspective:
EPS focuses on a company’s net income and does not consider other important financial metrics such as cash flow or return on equity. A company may have a high EPS but still be struggling financially.
Adjustment for Inflation:
EPS is not adjusted for inflation. This means that EPS figures over time may not be comparable due to changes in the cost of goods and services.
How Do You Calculate EPS Using Excel?
To calculate EPS (Earnings Per Share) using Excel, you will need the following information:
Net income: This is the company’s total earnings after deducting all expenses and taxes.
Number of outstanding shares: This is the number of shares of common stock that have been issued and are currently held by shareholders.
Once you have this information, you can use the following formula to calculate EPS:
EPS = Net Income / Number of Outstanding Shares
Here’s an example of how you can calculate EPS using Excel:
- In cell A1, enter the heading “Net Income”.
- In cell A2, enter the company’s net income.
- In cell B1, enter the heading “Outstanding Shares”.
- In cell B2, enter the number of outstanding shares.
- In cell C1, enter the heading “EPS”.
- In cell C2, enter the formula =A2/B2 to calculate EPS.
- Press enter, and the EPS will be displayed.
You can use the same formula to calculate EPS for different periods; just change the net income and outstanding shares accordingly.
You can also use the same formula to calculate EPS for different companies and compare their profitability.
Why is EPS important?
The following are the importance of EPS:
Comparison of Earnings:
EPS provides a standard way to compare a company’s earnings to that of its peers. It allows investors to compare the earnings of different companies within the same industry or sector.
Evaluation of Profitability:
EPS is an indicator of a company’s ability to generate profits for its shareholders. A high EPS generally indicates that a company is profitable, while a low EPS can suggest the opposite.
Investment Decisions:
EPS is one of the key metrics used by analysts and investors to evaluate a company’s performance and make investment decisions. A high EPS can indicate that a company’s stock is undervalued, while a low EPS can indicate that a company’s stock is overvalued.
Valuation Metrics:
EPS is used in several valuation metrics, such as the Price-to-Earnings (P/E) ratio and Earnings Yield, which help to compare the valuation of companies.
EPS Growth Rate:
EPS growth rate is the rate at which the earnings per share is increasing, it tells about the company’s ability to grow its earnings over time. This helps to predict the future growth potential of a company.
Tips for Investors
Here are some tips for investors when using EPS as a metric to evaluate a company’s performance and make investment decisions:
Look for Consistency:
A company with consistently high EPS is generally considered to be more stable and predictable than a company with volatile EPS.
Compare to Peers:
Compare a company’s EPS to its peers within the same industry or sector. This will give you a better understanding of how the company performs relative to its competitors.
Consider Other Metrics:
EPS is just one metric and should not be used in isolation. Other financial metrics such as cash flow, return on equity, and revenue growth should also be considered when evaluating a company’s performance.
Check the Company’s Capital Structure:
EPS does not consider a company’s capital structure, such as the number of outstanding shares or the use of debt financing. This can make it difficult to compare the EPS of companies with different capital structures.
Check the Earnings Quality:
EPS is subject to manipulation through accounting techniques such as aggressive cost-cutting or deferring expenses. So, it’s important to check the quality of earnings.
Check the Earnings Growth Rate:
EPS growth rate is the rate at which the earnings per share is increasing; it tells about the company’s ability to grow its earnings over time. This helps to predict the future growth potential of a company.
Check the Valuation Metrics:
EPS is used in several valuation metrics, such as the Price-to-Earnings (P/E) ratio and Earnings Yield, which help to compare the valuation of companies.
Consult a Financial Advisor:
Before making any investment decisions, it’s always a good idea to consult a financial advisor who can help you understand the risks and potential returns associated with investing in a particular company.
Conclusion
Earnings Per Share (EPS) is a widely used metric that provides a standard way to evaluate a company’s profitability and compare it to that of its peers. A high EPS indicates a company is profitable and can be a positive sign for investors.
However, EPS is just one metric and should not be used in isolation. When evaluating a company’s performance, investors should also consider other financial metrics such as cash flow, return on equity, and revenue growth.
Additionally, EPS is subject to manipulation, and Earnings Quality should be considered. It’s always important to research and consult a financial advisor before making any investment decisions.
Frequently Asked Questions (FAQs)
1. What is the difference between EPS and Adjusted EPS?
EPS represents the portion of a company’s profit allocated to each outstanding share of common stock. Adjusted EPS is a modified version of EPS that excludes certain items, such as one-time charges or gains.
EPS provides a standard way to compare a company’s earnings to that of its peers, while adjusted EPS provides a more accurate picture of its underlying earnings performance.
2. Why is EPS important for investors?
EPS is important for investors because it provides a standard way to compare a company’s earnings to that of its peers, helps evaluate a company’s profitability, is used in making investment decisions, and is used in valuation metrics. The EPS growth rate is also important as it tells about the company’s ability to grow its earnings over time.
3. How to use EPS in making investment decisions?
When making investment decisions, investors should look for consistency in a company’s EPS, compare the EPS to that of its peers within the same industry or sector, consider other financial metrics such as cash flow, return on equity, and revenue growth, check the company’s Capital Structure, check the Earnings Quality and check the valuation metrics such as Price-to-Earnings (P/E) ratio and Earnings Yield.
4. How to compare the EPS of different companies?
To compare the EPS of different companies, investors should look at the EPS figures of the companies in question and compare them to each other.
Additionally, investors should also consider other financial metrics such as cash flow, return on equity, and revenue growth, and check the company’s Capital Structure, Earnings Quality, and the valuation metrics such as Price-to-Earnings (P/E) ratio and Earnings Yield to get a more comprehensive picture of the company’s performance.
5. How to check the Earnings Quality of a company?
Investors can check the Earnings Quality of a company by looking at the company’s financial statements, looking for any unusual or one-time items that may have affected the company’s net income, and comparing the company’s EPS figures to those of its peers within the same industry or sector.