Earnings per share (EPS) stands as one of the most widely watched and important financial metrics in investing. This fundamental indicator helps investors gauge a company's profitability on a per-share basis, making it easier to compare performance across companies of different sizes and share prices.
Whether you're a seasoned investor or just beginning to explore the stock market, understanding EPS can help you make more informed investment decisions. This comprehensive guide explores what earnings per share means, how it's calculated, its variations, limitations, and practical applications.
Earnings per share (EPS) is a financial ratio that measures a company's net profit divided by the number of outstanding shares of its common stock. It represents the portion of a company's profit allocated to each outstanding share of common stock, essentially telling you how much money a company makes for each share.
EPS serves as a key indicator of a company's profitability and is often considered one of the most important variables for determining share prices. It's also a critical component in calculating the price-to-earnings (P/E) ratio, another popular valuation metric.
The basic formula for calculating EPS is:
Where:
Let's break down the process of calculating basic EPS:
Locate the net income (or net earnings) on the company's income statement for the period you're analyzing. This figure represents the company's profit after all expenses, including taxes and interest.
If the company has issued preferred stock, subtract any preferred dividends from the net income, as these are not available to common shareholders.
Calculate the weighted average of outstanding shares throughout the reporting period. This accounts for any changes in the number of shares due to stock issuances, repurchases, or splits.
Perform the division to arrive at the EPS figure.
Let's look at a straightforward example:
Company XYZ has:
Calculating the EPS:
This means that Company XYZ earned $3.00 for each outstanding share of common stock.
Several variations of EPS exist, each serving different analytical purposes:
Basic EPS uses only the current outstanding shares in its calculation, as shown above.
Diluted EPS includes all potential common shares that could become outstanding through the conversion of convertible debt, preferred stock, stock options, and warrants. It answers the question: "What would EPS be if all convertible securities were exercised?"
The formula for diluted EPS is:
Diluted EPS is always lower than or equal to basic EPS and provides a more conservative view of a company's earnings power.
Trailing EPS (or TTM EPS) is calculated using the company's actual earnings over the past 12 months. It's based on historical data and therefore represents real, achieved results.
Forward EPS is based on analysts' projections of a company's future earnings, typically for the next 12 months or fiscal year. While speculative, forward EPS helps investors assess a company's future prospects.
Reported EPS (or GAAP EPS) follows Generally Accepted Accounting Principles and includes all gains, losses, and one-time events.
Adjusted EPS (or non-GAAP EPS) excludes one-time or unusual items that companies argue don't reflect ongoing business operations, such as restructuring costs or asset impairments. Companies often highlight adjusted EPS to present what they consider a more accurate picture of their operational performance.
Earnings per share serves several important functions for investors:
EPS directly shows how much profit a company generates for each share, making it a fundamental measure of profitability.
By converting earnings to a per-share basis, EPS enables meaningful comparisons between companies with different sizes and share structures.
EPS forms the basis for other key valuation metrics, most notably the price-to-earnings (P/E) ratio:
EPS helps investors evaluate whether a company's dividend payments are sustainable. The payout ratio (dividends per share divided by EPS) indicates what percentage of earnings is being returned to shareholders.
Changes in EPS over time show a company's earnings growth trajectory, a key factor in investment decisions and stock price movements.
Analyzing EPS growth rates provides valuable insights about a company's expanding (or contracting) profitability:
Comparing EPS figures from the same quarter in consecutive years shows how a company's profitability is evolving while controlling for seasonal factors.
Examining EPS changes from one quarter to the next highlights more recent momentum, though this approach requires awareness of seasonal business cycles.
Looking at EPS over multiple years reveals fundamental patterns in a company's profitability trajectory, helping investors distinguish between temporary fluctuations and structural changes.
Calculating the CAGR of EPS over a multi-year period provides a smoothed growth rate that accounts for compounding effects:
Multiple factors can influence a company's EPS figures:
Increasing sales typically leads to higher earnings, boosting EPS if share count remains stable.
Improving profit margins through cost reductions or higher-margin products can increase EPS even without revenue growth.
When companies repurchase their own shares, the total number of outstanding shares decreases, potentially increasing EPS even if total earnings remain unchanged. This is sometimes criticized as "financial engineering" when used primarily to boost EPS.
Strategic acquisitions can increase total earnings, though the impact on EPS depends on how the acquisition is financed (cash vs. stock) and the relative profitability of the acquired business.
Shifts in accounting practices, write-downs, or one-time events can significantly impact EPS, which is why analyzing trends and adjusted figures is important.
While valuable, EPS has several important limitations investors should recognize:
Companies can boost EPS through accounting choices, share repurchases, or by excluding certain expenses in adjusted EPS figures.
EPS doesn't account for debt levels, so a company might boost EPS by taking on excessive debt to finance operations or share repurchases.
EPS is based on accounting income, which can differ significantly from cash flow due to non-cash expenses and accrual accounting principles.
Comparing EPS values directly between companies can be misleading, as a 50 share price represents a different return percentage than 100 share price.
Traditional EPS measures look backward at past performance rather than forward at future prospects, though forward EPS estimates attempt to address this.
Let's look at how EPS figures might be interpreted in different scenarios:
Company A reports:
Interpretation: This shows steady, slightly above-average growth, typical of a mature but healthy company. Investors might view this positively if looking for stability and moderate growth.
Company B reports:
Interpretation: The exceptional growth rate suggests a company expanding rapidly, potentially justifying a high P/E ratio despite the relatively low absolute EPS figure.
Company C reports:
Interpretation: The declining EPS trend raises concerns about long-term viability, though the company may still be profitable enough to deliver dividends in the near term.
Investors typically use EPS in conjunction with other metrics for comprehensive analysis:
The P/E ratio (price divided by EPS) indicates how much investors are willing to pay for each dollar of earnings. A high P/E might suggest expectations of strong future growth or overvaluation, while a low P/E could indicate undervaluation or expected earnings decline.
The price/earnings-to-growth (PEG) ratio divides the P/E ratio by the expected earnings growth rate, providing context for high or low P/E ratios:
A PEG ratio under 1.0 is often considered potentially undervalued.
Comparing the dividend per share to EPS helps assess dividend sustainability:
A lower ratio suggests more room for dividend increases or reinvestment in the business.
Looking at EPS trends over multiple quarters and years reveals the consistency and direction of a company's profitability, often more important than any single EPS figure.
EPS figures are typically reported in several standard ways:
Public companies report EPS quarterly as part of their mandatory financial disclosures, allowing investors to track short-term performance.
Year-end reports provide comprehensive EPS information, often with management discussion and analysis explaining factors affecting earnings.
Company executives discuss EPS results and often provide forward guidance during quarterly earnings conference calls with analysts and investors.
The income statement contains the raw data needed to calculate EPS, though most companies explicitly state their EPS figures in financial reports and press releases.
There's no universal "good" EPS figure, as appropriate levels vary greatly by industry, company size, growth stage, and market conditions. More important than the absolute number is the trend (is EPS growing?) and the relationship to the stock price (is the P/E ratio reasonable for the company's growth prospects?).
This usually occurs when a company reduces its outstanding share count through share repurchases. If the percentage decrease in shares exceeds the percentage decrease in net income, EPS will rise despite falling profits.
Stock splits proportionally adjust both historical EPS figures and the number of shares, so they have no real impact on the economic meaning of EPS. For example, after a 2-for-1 split, the share count doubles and the EPS is halved.
Diluted EPS accounts for the potential conversion of securities like stock options and convertible bonds into common shares, which would increase the share count and spread earnings across more shares, reducing the per-share figure.
Public companies typically report EPS quarterly, aligned with their financial reporting calendar, though they also provide annual EPS figures. Some companies also provide monthly or other periodic updates.
Companies provide EPS guidance to help manage market expectations about future performance. This practice helps reduce market volatility and aligns investor expectations with management's outlook.
Analysts develop forward EPS projections by building financial models that forecast a company's revenue, expenses, tax rates, and share counts based on industry trends, company guidance, economic data, and their own research and assumptions.