What is Earnings Per Share?

Formula and Calculation for EPS

As aforementioned EPS can be calculated by dividing net profit by a company’s outstanding shares. However, there are ways to further refine this calculation in terms of relevancy. This is done by altering the numerator and denominator of our calculation to compensate for additional shares added on from options, warrants, and convertible debt.

The more refined calculation one would see on balance sheets and income statements would consist of the numerator being the net income subtracting the company’s preferred dividends, and the denominator would consist of the end of period common shares that are still outstanding. This calculation is seen as more accurate as it uses a weighted average for the number of common shares reported in a given period as that amount does indeed change over time, in turn, making this method of calculating EPS superior.

Also, note that stock dividends and or splits that transpire must also be taken into account for the weighted amount of common shares outstanding. Although, some simplify this by simply using the number of common shares outstanding at the end of a specified period.

Example of EPS

How is Earnings Per Share Used?

Earnings per share is an imperative metric for calculating a company’s profitability, although it is similarly a fundamental factor for calculating price to earnings assessment ratio. This price to earnings ratio can also be represented by P/E where the E represents earnings per share.

Essentially, when dividing a company’s share price by its earnings per share, one can calculate the “value” of the stock in reference to how much of the stock market pays for a dollar of the earnings. However, note that earnings per share can be used as an indicator when deciding on a stock to invest in.

When comparing earnings per share to other indicators it may not have a significant impact or meaning to investors as normal shareholders/investors have no access to the company’s earnings. In reality, investors compare EPS with share price to determine an estimated value of total earnings which influences how they feel about potential company growth.

Basic EPS vs. Diluted EPS

One should note that in the previous example a calculation of “Basic EPS” was being performed. Basically, basic EPS does not account for diluted shares that often can be issued by a given company. Principally, the capital structure of a given company consists of things like stock options, RSUs, or warrants. These items could increase the total number of outstanding shares in the market if exercised.

Fundamentally, the prominent effects that certain investments or securities have on EPS carry over to diluted EPS, only if one is assuming that the outstanding shares have already been issued. As an example, say the total number of shares issued for a given company from their convertible securities was 10 million. Since the number is added to the total common shares outstanding, the diluted average of the shares outstanding would be $100 million plus $10 million, making for $110 million shares. Therefore, let’s say the company’s diluted EPS would be $10 billion divided by the previously calculated $110 million making for a diluted EPS of around $91.

One should note an adjustment to the numerator of EPS is often required when calculating diluted EPS. Essentially, when a given entity provides a loan that one can convert into shares (Convertible Bonds). This means that shares would be created by the convertible bond or debt security need to be included in the diluted EPS calculation, but technically if they are included the company would not have paid interest for the debt security. What will then happen is the company will take the unpaid interest and add it to the numerator of EPS to account for the error in the calculation.

EPS Excluding Extraordinary Items

EPS is often inaccurate due to several factors whether it be intentionally done by a company or not. Financial analysts will use certain kinds of basic EPS to avoid these errors so the EPS they calculate does not appear inflated and in rare cases, deflated. For example, say a real estate company owns 2 houses in a metropolitan area. One of the locations is considered to be very valuable. Say the company decides to sell the extremely valuable home so they can build a new home in a less valuable area on a smaller lot. This will create an unexpected profit for the company. Although, the sale of the initial home has also created profits for the company and its shareholders. This means that it is to be considered an extraordinary item as it is unlikely the company can repeat the same process to the same magnitude of profit again. This leads to the shareholders being potentially uninformed of the unexpected profit being included in the EPS numerator, therefore, it is excluded.

The same situation could occur if a company has an unexpected loss. For example, let’s say the house never sold as no one wanted to buy it despite its value. This would decrease EPS and, in turn, is excluded for the same reason as before.

The calculation from EPS without extraordinary items is.

EPS from Continuing Operations

Businesses close stores, begin new projects and proceed with basic operations every day, and by continuing said operations companies will often gain EPS from them. For example, if a company was to close stores that were operating at a deficit a financial analyst is going to want to know what the EPS is for the remaining stores they still have operating. The analyst won’t always see an increase in EPS but because these stores were operating at a loss EPS could rise. In the end, evaluating EPS from a company’s ongoing operations is an important tool when comparing a company’s previous and current performance.

EPS & Capital

In the EPS calculation, there is the capital amount which a company needs to create profit in the EPS calculation. This capital amount is quite important, especially when comparing one or more companies. For example, say two companies have the same EPS but one operates with fewer expenses meaning that said company is more proficient when it comes to using its capital to create profit. Assuming everything else is equal the better company would be the one which is more effective at using its capital. However, one should note that a better way to identify efficient companies is by using the ROE calculation.

EPS & Dividends

As aforementioned EPS is used to calculate a company’s profitability but investors do not have access to a company’s profits. Some of these profits are often distributed as dividends but most of the EPS is kept by the company themselves. However, there is a way for shareholders to get access to more of these profits, and it is when the board of directors change the percentage of EPS supplied as dividends to have access to more of those earnings.

EPS & P/E

As an investor, it may be useful to analyze the price to earnings ratio (P/E) for a given industry. A stock that costs more than its EPS in comparison with fellow companies within the same industry is often seen as overvalued, but the contrary is what’s accurate. Basically, investors will pay more for a stock despite its prior EPS values if said stock is on track to see increased growth in the industry it is a part of.

During a bull market, it is common for the stocks with the highest P/E levels in a stock market index to outperform the index’s average.

What is a Good EPS?

What is a good EPS? Well, it depends on a multitude of factors. These include the profitability and performance of the company, the profitability and performance of competitors, and the expectations of investors who actively track the stock. Note that when companies report high EPS the stock could decline if investors & analysts expected higher EPS. Similarly, smaller reported EPS might lead to a stock increase if investors & analysts expected an even lower EPS.

Investors should always evaluate EPS in connection to the company’s stock price by examining the P/E or a company’s earnings yield.

What is the Difference Between Basic EPS & Diluted EPS?

Investors will differentiate between basic and diluted EPS. Basic EPS is calculated by dividing the company’s net income by the number of outstanding shares. It is the commonly used metric in the market and also the simplest way to define EPS. Because it contains a more wide definition of outstanding, common shares for a given company, diluted EPS is always comparatively lower than basic EPS or equal to it. It includes shares that are not outstanding but might become so if preferred shares and other convertible securities are redeemed.

What is the Difference between EPS & Adjusted EPS?

Adjusted EPS is a version of EPS where the numerator is modified by the analyst or investor using doing an EPS calculation.  Essentially, this entails adjusting or eliminating non-repeating factors of net income. For example, if somehow the company’s net income was increased as a consequence of a one-time transaction, the investor or analyst can remove the proceeds from that transaction, lowering the, in turn, decreasing net income. In those kinds of cases, the adjusted earnings per share will be lower as a consequence of the adjustment.

What are the Limitations of EPS?

When using EPS for an investment decision one should look out for potential downsides. For example, companies can manipulate their profits per share by repurchasing their shares, in turn, lowering the number of outstanding shares, and increasing the EPS for the same amount of earnings as the original.

Differences in accounting policies for reporting results can have an impact on EPS. Although, keep in mind  EPS does not consider the stock value which, in turn, meaning that it does not correlate with a company’s stock being over or undervalued.

How Do You Calculate EPS Using Excel?

After gathering the appropriate information, enter the net income, preferred dividends, and the number of outstanding common shares into three adjacent cells. Then, to remove preferred dividends from net income, enter the formula subtract the appropriate cells in another adjacent, and to calculate the EPS ratio, enter the formula divide the appropriate cells in another adjacent cell.