What is EPS?
Earnings per share (EPS): It is defined as amount of earning that each outstanding share of common stock can earn.
It is determined from the figure gotten by dividing the company’s net income by the total of the number of the existing shares of stocks.
EPS is financial ratio that derives from net earnings accessible to common shareholders divided by the weighted number of outstanding shares over a given period.
The EPS formula shows investors how much net profits a company has generated for common shareholders. In this guide, you will find Earnings per Share formula explained in detail.
One EPS for a single company is not all that meaningful although it does give a general idea of value per equity share.
The number is more useful when it is compared to other companies within the industry and to the company’s stock price (the P/E Ratio).
Among two companies in the same industry with equal number of outstanding shares, the company with higher EPS suggested better earning.
EPS is usually combined with the share price to decide if the business is undervalued, with a low P/E ratio or overvalued, with a high P/E ratio.
Key Takeaways
- EPS represents net income of total for a company minus preferred dividends and divided it by the total number of common shares.
- EPS refers to amount of profit earned per share of the company stock and is the common figure used to predict corporate value.
- It is a measure of value because investors tend to pay more for a company’s shares if they expect that company to earn more per share than the price they are going to pay.
- EPS can be reached in different ways such as; Excluding extra-ordinary items or operations Discontinued operations EPS on diluted basis.
- As with all financial ratios, EPS is most beneficial being compared to competitor ratios, or other companies in the same industry or better yet, at different points in time.
Earnings Per Share Equation
Earnings per share value is computed by net income, otherwise referred to as profit or earnings, divided by the available number of shares.
A better approximation modifies the numerator and denominator for those shares that can only be created via options, convertible debt or warrant.
So if the numerator of the above equation is also adjusted for continuing operations then, it is more relevant.
To determine a company EPS, the balance and the income statement are used to determine the period-end general number of an outstanding common stock, the preferred stock dividend if any, and the earnings or the net income. The number of shares is variable over time, and that is why it will be more appropriate to calculate the weight average number of common shares within the reporting period. It is also important to know how to identify EPS especially when assessing the profitability positioned of a company.
Earnings Per Share Formula = (Net Income – Preferred Dividends)/Weighted Average Number of Shares Outstanding
There are additional requirements for calculating share splits or dividends such as these should affect the weighted average number of shares out stood.
To simplify some data sources only consider the number of shares outstanding at the end of a period.
Three steps to calculate the weighted average number of common shares outstanding:
Determine the common share account at the start of the year and any alterations made to common share balance in the year.
For each change in the common shares:
- Step 1 – Determine how many shares of stock are outstanding after each alteration of the common shares. The cost of retaining such experts increases as well, since the more shares are issued, the greater the total number of shares outstanding. The effects of the policy of the buyback of shares is to decrease the number of issued shares in the market.
- Step 2 – Weight the shares outstanding by the portion of the year between this change and the next change: No of days outstanding = weight x 365 weight = days outstanding / 365 No of months outstanding = weight / 12
- Step 3 – Addition to get the weighted average number of common shares in circulation.
What Does Earnings Per Share (EPS) Indicate
Earnings per share is one of the financial parameters used when evaluating a firm’s profitability to the greatest extent. It also goes together with formation of the price earnings (P/E) ratio where the ‘E’ stands for earnings per share.
With help of dividing share price to earnings per share ratio, an investor can understand how much market is willing to pay for each dollar of its earnings.
Earnings per share, when used with other indicators reveal how an investor can go about selecting stock.
If you have a passion in trading of stocks, or investing, your next move will be to select a broker that is suitable for your personality.
Comparing EPS in terms of absolute figures does not hold much importance to the investors simply because they cannot get their hands on the earning as ordinary shareholders.
However, investors will divide, EPS by the price of the share in order to assess the worth of earnings and the investor sentiment towards future growth.
Effect of Stock Dividends & Stock Splits on EPS
In arriving at the average number of shares, stock dividends or stock splits affect only the units of measures and not measurement of change in ownership of earnings. a share of stock or of a company’s equity for its stockholders or shareholders).
When there is a declaration of stock dividend or stock split, the analysis of the weighted average number of shares also involves restatement of shares outstanding before declaration of stock dividend or stock split. It is not multiplied by the year’s portion after the stock dividend or split, therefore.
Specifically, before starting the three steps of computing the weighted average, the following numbers are restated to reflect the effects of the stock dividend/split:
The number of shares at the start of a period before any issuances or purchases have occurred; It covers the issuance or purchase of shares any time before the stock dividend or split. There is no adjustment for shares that are issued or bought after the date of a stock dividend or stock split.
And if a stock dividend or split has taken place after the end of the year but before the preparation of the financial statements, then the weighted average number of shares for that year (and any other year in the form of the comparative form) must be adjusted.
Example
Calculate the weighted average number of shares for the following –
The weighted average number of shares is calculated as per below –
Colgate’s Stock Dividends and Earnings Per Share
As a result of 2013, all historical per share data and numbers of shares outstanding were retroactively adjusted. In 2012, the shares outstanding were 476.1 million, and they almost doubled up to 930.8 million due to the two-for-one stock split.
How Earnings Per Share Affects Stock Valuation
Earning is the company’s power to turn its revenues into profits and is normally viewed as the greatest barometer of financial well-being.
The public-listed companies’ earnings are announced in a fiscal year four times, and we would also like to point out that scholars and investors pay precisive attention to this season.
Increased for better still the symbol EPS is simply a pointer to a company whose performance is great and, in a way, delivering returns to the investor.
EPS is direct to the stock markets by the wide tracked Wall Street PE Multiple or Price/EPS ratio.
The above PE multiple is relative to the industry average PE, and the lower the PE multiple the better it is from investments as well as valuations.
Much the same reaction is seen in quarterly earnings for stock prices.
For instance, the Blackberry Ltd share price over the monthly and quarterly periods after the earnings report release. Check the huge fluctuation in stock prices. For more information on Enterprise Value and Equity Value.
Basic EPS vs. Diluted EPS
The value in the right most column in the table above represents the basic EPS for each of these select companies.
In simple, Basic EPS does not take into account the effect, shares could be issued by the company.
If the company has items in its capital structure such as stock options, warrants or restricted stock units (RSUs) and these are exercised they dilute the company’s shares in the market.
To show the shareholders the impact such securities would have on per share earnings, companies report both basic and diluted earnings per share A company’s diluted EPS is its basic EPS adjusted for all shares that could be issued.
For instance the number of shares that can be created and issued from the instruments of Company C as of the end of its fiscal year was 23 million.
In this case, the company’s diluted weighted average shares outstanding will be the total amount of shares outstanding by adding this number of shares to the current figure; that is 541 million +23 million equals to 564 million shares. Hence the company diluted EPS is, $1.67 billion /.564 million = $2.96.
In some situations, changes need to be made on the numerator part of a fully diluted EPS formula.
For instance, at certain conditions, the lender will give a loan that is then secured by the conversion of the debt into stock.
The number of shares that should bees be issued by the convertible debt should see the shares that would be created by the convertible debt be reflected in the denominator of the diluted EPS calculation, but if that were to occur there would be no interest paid on the debt.
Otherwise, the interest paid on convertible debt will be added back into the numerator of the EPS calculation by the firm or analyst to give out a non-inflated figure.
FAQ’s
What are the types of EPS?
- Basic EPS: Derived from company’s net income and with the total no. of shares of stocks available in the market today.
- Diluted EPS: Explains the impact of potential shares such as share options, convertible bonds etc.
- Adjusted EPS: Excludes items that are not relevant from an operating profit level as these are considered as one-off or extraordinary events.
- Trailing EPS: Refers to an earning from the last one year of operation of the business.
- Forward EPS: It however offers estimates of future earnings by use of forecasts.
On the side of advantage, what can be offers by EPS?
- Indicator of Profitability: Easy indicator to measure financial performance and is easily understandable by each and every person.
- Comparability: Of significant use while comparing companies that belong to the same line of business.
- Input for Valuation: In use when determining the estimated earnings rates and making some investment decisions.
What may entice some investors might the disadvantages of using EPS?
Doesn’t Account for Debt: EPS does not represent the utilization of the firm’s assets or leverage level.
Subject to Manipulation: Changes in the accounting measurement methods brings about changes in EPS.
Limited Scope: Is not useful when it comes to giving a comprehensive picture of a company’s performance.
How is diluted EPS different from basic EPS?
Diluted EPS reflects effect of items such as convertible securities including stock option and warrants, and present a more realistic or conservative picture of the EPS after a company has issues new shares.
What affects EPS values?
Changes in net income.
The offering or repurchase of the company’s shares.
Adjustments to account amounts or other, for, extraordinary items.
When should adjusted EPS be used?
Adjusted EPS should be used when you’d prefer to analyze the company’s constant or primary earnings, outside of special dividends or charges such as a sale of equipment or a specific expense.
Why EPS is so crucial for investors?
It is really essential since EPS provides information on profitability that reflects the company’s stock price and valuation ratios like the P/E ratio.