EPS (Earnings Per Share) Definition
Define EPS In Simple Terms
Earnings per share, or EPS, is a ratio that compares a company’s profits with the number of shares outstanding to evaluate profitability.
For example, if a company earned $7 million in profits, paid shareholders $2 million in dividends, and had 1 million shares outstanding, the company’s EPS would be $7 million-$2 million / 1 million, or $5 per share.
This formula gives a company’s basic EPS.
Many companies also report their diluted EPS, which is the earnings per share if a company were to issue all of the shares it had available rather than just the shares that are currently outstanding.
This considers both normal unissued shares and shares that could be obtained from convertible bonds.
Since interest on those bonds is a part of a company’s income, so to avoid distortion, analysts add the interest back into the numerator while also including the new shares in the denominator.
Increasing the number of shares reduces, or dilutes, the EPS.
What Does EPS Mean in Finance?
The purpose of calculating EPS is to give investors an idea of a company’s earning potential in terms of return on investment.
Because EPS directly shows how much money a company is earning per share outstanding, it is a way to approximate the overall profitability of a company.
It is a critical component of determining the price-to-earnings, or P/E, ratio.
This ratio divides the price of a share by the EPS to determine how much the investor is paying per share to get a dollar’s worth of earnings.
The P/E ratio is useful to investors when determining the current attractiveness of an investment.
Adjustments to Net Income
1. Extraordinary Items
Because some large, one-off purchases or revenues are unlikely to happen again, such as the sale of a warehouse or payment on a lawsuit, “extraordinary items” are often removed from the net income calculation.
2. Discontinued Operations
Similarly, since the profits from discontinued operations (businesses of a company that will no longer be operating) will not be earned in the future, they may be removed when calculating net income.
3. Preferred Stock Dividends
While preferred dividends are not typically deducted from net income, they typically are when calculating earnings per share.
This is because, like debt, they are an obligation required to be paid before the common stockholders receive dividends.
Adjustments to Common Stock Outstanding
1. Weighted Average Shares Outstanding
Common Stock Outstanding is all stock outstanding on the day of calculation.
This number changes often, so investors sometimes use the weighted average of the shares outstanding to determine the EPS for a specific time period.
When calculating the quarterly EPS for a company, using the weighted average shares outstanding for the time period may give you a better picture than the shares outstanding on the last day of the quarter.
2. Share Dilution
Companies may issue stock or individuals may exercise options at any time, so some investors instead calculate a diluted earnings per share, which calculates a “worst case scenario” earnings per share figure if all of its convertible securities were exercised.