Earnings per Share (EPS)

A portion of company's profit that is allocated among all outstanding shares of common stock. The profitability of a corporation is shown by EPS.

Demystifying Earnings Per Share (EPS) and Its Calculations

Have you ever wondered about Earnings Per Share (EPS) and how it can shed light on a company's financial performance? Well, you're in the right place. In this blog post, we'll dive into the intricacies of EPS, what it signifies, and the process to calculate it.

Understanding Earnings Per Share (EPS)

Earnings per share (EPS) is a crucial financial metric that showcases a company's profitability. It's essentially a company's net profit divided by the total number of outstanding common shares. The resulting number is a key indicator of a company's financial well-being and is frequently adjusted to account for extraordinary items and potential share dilution.

Key Insights

- EPS quantifies how much profit a company generates for each outstanding common share.

- It's a widely used metric for estimating a company's value, as investors are generally willing to pay more for shares in a company with higher EPS.

- Different forms of EPS can be calculated, such as excluding extraordinary items, discontinued operations, or considering dilution.

- To assess EPS effectively, it's essential to compare it with competitor metrics or analyze it over time.

What Does Earnings Per Share (EPS) Entail?

EPS is a financial metric that reveals how much a company earns for each common share available to investors. Higher EPS typically indicates greater profitability, which can influence how investors perceive a company's value in the market.

The Formula and Calculation for Earnings Per Share (EPS)

Calculating EPS is straightforward. You simply divide the company's net income by the end-of-period common shares outstanding. To ensure accuracy, it's crucial to use the weighted average number of common shares over the reporting period, as the number of shares can change due to events like stock dividends or splits.

Earnings Per Share (EPS) = (Net Income – Preferred Dividends) ÷ Weighted Average Common Shares Outstanding

An Example with FAANG Stocks

Let's illustrate EPS with a practical example involving three well-known companies at the end of a fiscal year:

- Apple ($AAPL): Net Income $28.755, Weighted Common Shares 16.935. Basic EPS: $1.70
- Amazon ($AMZN): Net Income $7.222B, Weighted Common Shares 502M. Basic EPS: $14.39.
- Tesla ($TSLA): Net Income $690M, Weighted Common Shares 933M. Basic EPS: $0.74.

The Practical Application of EPS

EPS serves a crucial role in assessing a company's profitability and is a key component in determining the Price-to-Earnings (P/E) ratio. By dividing a company's share price by its EPS, investors can gauge the value of a stock and make informed investment decisions.

Basic EPS vs. Diluted EPS

Basic EPS provides a straightforward calculation without accounting for potential dilution due to factors like stock options or warrants. In contrast, diluted EPS considers these potential shares, offering a more comprehensive perspective on earnings.

EPS Excluding Extraordinary Items

EPS can be influenced by various factors, both intentionally and unintentionally. Analysts often adjust the basic EPS formula to exclude extraordinary items that are unlikely to recur in the future to prevent distortion.

EPS From Continuing Operations

Analyzing EPS from continuing operations helps provide a more accurate evaluation of a company's performance, especially when certain operations have been discontinued.

The Role of Capital in EPS

It's essential to consider the capital required to generate earnings (net income) when evaluating EPS. This can be done by examining a company's return on equity (ROE), which can identify more efficient companies that generate income with fewer net assets.

EPS and Dividends

While EPS is a significant metric for assessing a company's performance, shareholders don't have direct access to these profits. Dividends, a portion of the earnings, must be distributed through the board of directors, allowing shareholders to access their share of the profits.

EPS and Price-to-Earnings (P/E)

Comparing P/E ratios within an industry can provide valuable insights into a stock's value. Investors are often willing to pay more for stocks expected to outperform their peers, even if they have higher P/E ratios.

Determining a Good EPS

What qualifies as a "good" EPS depends on various factors, including a company's recent performance, competitor benchmarks, and analyst expectations. It's crucial to assess EPS in the context of a company's share price, P/E ratio, or earnings yield.

Distinguishing Basic EPS from Diluted EPS

Basic EPS is calculated as net income divided by outstanding shares, whereas diluted EPS accounts for potential share dilution. Diluted EPS is always equal to or lower than basic EPS.

Understanding Adjusted EPS

Adjusted EPS involves modifications to the numerator to exclude non-recurring components, offering a more accurate view of a company's earnings.

Exploring the Limitations of EPS

While EPS is a valuable metric, it has limitations. It can be manipulated through stock buybacks and changes in accounting policies, and it doesn't consider share prices, making it less helpful in assessing a company's stock valuation.

Calculating EPS Using Excel

If you want to calculate EPS using Excel, it's a straightforward process. Input the net income, preferred dividends, and common shares outstanding in designated cells and use the formula "= (Net Income - Preferred Dividends) / Common Shares Outstanding" in another cell to calculate the EPS ratio.

In Conclusion

Earnings Per Share (EPS) is a critical metric for evaluating a company's profitability and making well-informed investment decisions. Understanding the nuances of EPS, its different forms, adjustments, and limitations is vital for a comprehensive financial analysis. By considering EPS alongside other financial indicators, investors can gain a more complete picture of a company's financial health and make strategic investment choices.