Calculation Formula & Example | Definition & Explanation | What is "Good" | Top Tips

In other words, if a company paid out all of its profits to shareholders, EPS is the portion of the **net income** that would be **allocated to each share**.

The **higher** a company’s EPS, the more **attractive** its shares are considered to be, and stock with earnings-per-share** steadily increasing** over time is regarded as a more **reliable** investment than one with a fluctuating or declining ratio.

- High EPS = High profitability
- Continuous EPS growth = Reliable investment

However, there is **no ideal** EPS figure or threshold.

Instead, the past performance and future prospects of a company and its stock are evaluated by **comparing** the EPS **growth** against:

- Previous accounting periods (e.g., quarter or year)
- Similar companies (e.g., industry benchmarks)
- Other forms of investment
- Company’s share price

Investors buy shares in a company for two main reasons:

**Dividends:**Receive dividend payments**Capital gains:**Sell the stock at a higher price as its market value increases in the future to make a profit

The **earnings** of a company **drive both** its dividend payments and the market value of stocks, because it has more money available to distribute through dividends or reinvest into the business.

Moreover, the EPS is used to calculate **other** important **ratios** that assess the return on investment into the ordinary shares of a company, including the Price/Earnings (P/E) ratio, Earnings Yield and Dividend Cover.

In fact, since the EPS figure is used to calculate the **P/E ratio**, a major stock market indicator of performance, it can have a significant effect on a company’s share price:

- Fall in EPS >> Fall in P/E ratio >> Potential fall in share price

That’s why EPS is a key investor ratio that enables existing and prospective shareholders to:

- Assess
**past performance**of a company and its stock - Estimate
**future earnings**and increases in market value - Evaluate
**market value**of stocks relative to earnings

However, the EPS has many shortcomings and **limitations** that can lead to **misleading** results and prevent you from using the ratio effectively.

That’s why you should be 100% clear on how to **calculate**, **interpret** and **use** EPS to your best advantage** >>>**

The formula for calculating EPS is:

**Earnings Per Share (EPS) = Earnings ÷ Shares**

As you can see, calculating basic Earnings Per Share is easy:

If a company with 1,000 shares earns $10,000, its EPS is simply $10 (= $10,000 **÷** 1,000).

However, although the ratio is simple in principle, many complications may arise in practice due to the different definitions and accounting treatments of both the earnings and shares:

In the EPS formula, the numerator refers to** Net Profit** (also known as Net Income or Net Earnings) distributable to ordinary (aka common) equity shareholders, which means earnings for the period:

*Less***interest**and**tax**

**Less****preference share dividends**paid in the period (EPS represents only the earnings available to common shareholders and preferred stock dividends take precedence before common shareholders are entitled to anything.)

profit from**Less****non-core extraordinary items**and**discontinued****operations**(exclude any unusual items that would temporarily distort the EPS to ensure it represents only earnings generated from core operations on a normalized basis)

profit attributable to any**Less****non-controlling**investment or**minority interest**(applies to consolidated financial statements where EPS is based on the consolidated profit attributable to the shareholders of the parent company)

Note that the earnings could amount to a **loss** (as opposed to a profit) attributable to ordinary shareholders.

In the EPS formula, the denominator refers to the number of **ordinary** (aka common) **equity shares outstanding** during all or part of the period.

- At its most simple form, the EPS calculation uses the number of shares outstanding
**at the end of a reporting period**.

- However, if the number of outstanding shares changes throughout the period, it is more accurate to calculate an
**average**or**weighted average**instead of just using the end-of-period figure.

- However, if the number of outstanding shares changes throughout the period, it is more accurate to calculate an

- The calculation generally uses the number of shares
**outstanding**(i.e., excluding treasury stock held by the public company itself) as opposed to the total number of all shares in issue.

Since EPS is the monetary value of earnings per outstanding share of common stock, it is expressed as **cents** per share to 1 decimal place.

Companies usually report their EPS on a **quarterly** or **annual** basis.

In addition to calculating the basic EPS as per above, you many need to know how to deal with more complex situations, including:

**Bonus**issue**Rights**issue- Share
**splits** **Diluted**EPS (DEPS) – conservative “worst case” scenario calculation that includes any dilutive securities (e.g., convertibles, options, warrants), which would increase the number of shares outstanding in the market–and reduce EPS–if exercised and converted to stock.- EPS calculated separately for each major
**category****of the income statement**(e.g., net income, continuing operations, discontinued operations, extraordinary items)

For that purpose, you need to consult the relevant financial reporting standards applicable in your country, such as the **IFRS – IAS 33** or **US GAAP – SFAS 128**, to ensure that the calculation and accounting treatment is in compliance with the local requirements.

The EPS can be calculated based on **historical** data (* Trailing* EPS),

EPS Types | Trailing | Forward | Current |
---|---|---|---|

Calculation | Previous 4 quarters. | Future 4 quarters. | Current fiscal year, some of the 4 quarters may have passed. |

Actuals | Yes | No | Yes |

Projections | No | Yes | Yes |

Pros | Represents what actually happened, not what may happen in the future. | Investors look for indication of future earning potential. | Combination of actuals and projections. |

Cons | “Old news” | Estimates, not reality. | Inconsistent and confusing. |

Most often, the EPS and P/E ratios are calculated using the **trailing** basis because it shows what **actually** happened in the past.

However, investors often use the other two calculations (forward and current) for **comparison** purposes.

For example, if the current actuals significantly lag behind the forward projections, the stock price may fall–and vice versa.

**Earnings Per Share Example:**

In the last quarter, Company XYZ generated a net income of $2 million and paid out a dividend of $500,000 to preferred shareholders. Its outstanding common shares stood at 12 million at the beginning of the quarter but the number fell to 10 million at the end of the period.

Here is how we calculate basic earnings-per-share for Company XYZ for the last quarter in **3 simple steps**:

Company XYZ - Financials | |
---|---|

Net Income: | $2,000,000 |

Preferred Dividend: | $350,000 |

Shares Outstanding - Opening: | 12,000,000 |

Shares Outstanding - Closing: | 10,000,000 |

**Step 1: Calculate the net income available to ordinary shareholders:**

Net income available to ordinary shareholders =

= ( $2,000,000 – $350,000 ) =

= $1,650,000

**Step 2: Calculate the average number of shares outstanding:**

Average number of outstanding shares =

= ( 12,000,000 + 10,000,000 ) ÷ 2 =

= 11,000,000

**Step 3: Calculate Earnings per Share:**

EPS = $1,650,000 ÷ 11,000,000 = $0.15

The EPS of Company XYZ for last quarter was 15c.

The EPS ratio is widely used as a performance measure between companies and sectors, as well as time periods within the same entity, thanks to its many advantages, including:

**Straightforward**to understand- Simple and
**fast**to calculate **Convenient**as input figures are readily available in the financial statements- Calculation is usually clearly defined by accounting
**standards**

When its earnings-per-share increase, it is an indication that a company is doing well financially and may present a good opportunity for investment.

However, as an overall measure of a company’s financial health, the EPS ratio has many **shortcomings**.

In fact, the widespread use of the EPS and P/E ratios in the investment community may be largely attributed to their ease of use, because the EPS otherwise has a number of **limitations**.

The EPS ratio on its own is arbitrary. Instead, it is best evaluated through **trend** analysis, by studying the growth rate of a company **over time**:

- Is its EPS growing or declining over time?
- What is the rate of growth/decline?
- Is the rate of growth increasing or decreasing?

For the EPS ratio to be comparable between accounting periods of one company and among different companies, it must be calculated on a **consistent** basis.

However, EPS may get easily distorted, for example by:

- Differences in
**accounting policy** **Changes in share capital**throughout the course of a year- Mergers and acquisitions (
**M&A**)

The EPS ratio is relatively **easy to manipulate**.

For instance, companies where EPS is used to determine **management bonuses** may be particularly motivated to influence the ratio through a share buy-back and consolidation, M&A projects, and changes in treatment of accounting items.

Let’s say that a company buys back its own shares in the open market. This move would improve the company’s EPS without actually increasing its net income, just because the net income now gets divided up by a fewer number of shares outstanding.

As a result, investors could be ‘tricked’ into thinking that the company is doing better than it actually is.

The correlation between EPS growth and shareholder value is unclear because the calculation is not directly linked to the objective of **maximising shareholder wealth**.

**Firstly**, earnings-per-share do **not** represent the **actual** **income** of ordinary shareholders because they do not have direct access to the earnings calculated by the ratio.

While there is a link between EPS and shareholder wealth, they are not the same thing.

Although a portion of a company’s earnings may be distributed as a dividend, the remainder of the EPS can be retained in the company. And some companies pay no dividends at all.

**Secondly**, high profit may be achieved at the expense of **reinvestment** back into the business to fuel future growth and sustainable value for shareholders.

When a company passes profits on to its stockholders via dividends or a share buyback, it results in a short-term gain for the shareholders. This needs to be balanced with the alternative of retaining the earnings in the company to increase shareholder returns in the long-term.

**Thirdly**, the Earnings Per Share are not necessarily directly related to the **market value** of a company and its stock.

For example, the EPS for two stocks with widely different share prices could be identical.

Since EPS does not take account of inflation, any increase in earnings likely does not reflect the** true growth**.

EPS is essentially a measure of profitability from shareholders’ perspective. However, profitability is only one aspect of company performance. As a result, focusing too much on the bottom line of a company is incomplete, **narrow-focused** and **short-sighted**.

There is a wealth of other financial and non-financial factors that come into play when it comes to the success of a company and an investment strategy.

By definition, the EPS is dependant on the **number** of shares in issue. This needs to be taken into account when comparing the earnings of companies against each other.

As an example, while both of these companies have EPS of 10 cents, the earnings of Company B are drastically lower:

EPS Example | Company A | Company B |
---|---|---|

Earnings | $10,000,000 | $25,000 |

Shares | 10,000,000 | 250,000 |

EPS | $10,000,000 ÷ 100,000,000 = 10c | 25,000 ÷ 250,000 = 10c |

Clearly, it is **meaningless** to compare EPS of one company with another without first calculating the EPS growth rates.

Moreover, the EPS calculation does not factor in the **outstanding debt** of a company.

EPS does not consider the **resources** needed to generate the income of a company.

Suppose that Company A and Company B report an identical EPS ratio. However, Company A needs significantly **fewer net assets** to achieve the same level of earnings as Company B because it is more **efficient** at utilizing its capital to generate revenue.

Nevertheless, the efficiency of Company A would not be directly reflected in its EPS.

While the EPS is an important and widely used tool for investors, a single absolute value for one company is **arbitrary** and using the ratio **in isolation** does not tell the whole story of a company’s financial strength.

Therefore, for the earnings-per-share analysis to be truly meaningful, the ratio must be evaluated in context and with the awareness of its limitations. Here are the **5 top tips** on how to do just that:

In order to assess a company’s real earning capability and spot trends, investors should compute the company’s EPS for more than one accounting period, and ideally over several **years**.

Look for **trends** in EPS **growth** to get a sense of how profitable a company has been to date and to estimate its future prospects.

- The
**higher**the EPS, the more**profitable**a company is considered to be. - A company with a steadily
**increasing**ratio is regarded to be a more**reliable**investment than one with significantly fluctuating or even declining earnings-per-share.

Compare the EPS to similar companies within the same industry, industry averages or other relevant benchmarks to determine how a company is performing relative to its **peers**.

For example, between two companies in the same industry with the same number of shares outstanding, and other things being equal, higher EPS indicates higher profitability.

Furthermore, investors should use the EPS figure in conjunction with other ratios and metrics to estimate the future growth, earnings, and stock value of a company.

Always analyse both the financial as well as non-financial elements to gain a **holistic** view of a company.

EPS is not paid out to shareholders. Earnings per Share (EPS) is a ratio of a company’s net income per each outstanding share, indicating its profitability. Dividend per Share (DPS) is the ratio that calculates the portion of EPS that is actually shared with stockholders through dividends.

Sign up for our Newsletter

Get more articles just like this straight into your mailbox.

Related Posts

Recent Posts

error: **Alert:** Content is protected