What is Earnings Per Share?
Earnings Per Share, commonly referred to as EPS, is a financial metric that investors and analysts use to evaluate a company’s profitability. It is the portion of a company’s profit allocated to each outstanding share of common stock. In simpler terms, it represents how much money the company has made for its shareholders. EPS is widely used in the market as a primary ratio to measure the financial health and growth prospects of a business.
To calculate Earnings Per Share, one must first determine the net income of a company during a specified time period. Net income can be found on the income statement and represents the total revenue minus the total expenses, which include operating costs, depreciation, interest, taxes, etc. Once you have calculated the net income, you need to find the weighted average number of shares outstanding during the same period. This involves taking into account any changes in share count due to activities like issuing new shares or buying back shares.
The formula for calculating Earnings Per Share is as follows:
EPS = Net Income / Weighted Average Number of Shares Outstanding
For example, if a company has a net income of $1 million and 500,000 shares outstanding, its Earnings Per Share would be $2 ($1,000,000 / 500,000).
There are two primary types of Earnings Per Share – Basic EPS and Diluted EPS. Basic EPS is calculated using only outstanding common shares in its calculation. In contrast, Diluted EPS includes all potentially dilutive securities such as stock options, convertible debentures, and convertible preferred stock in its calculation. As a result, Diluted EPS will generally be lower than Basic EPS.
Earnings Per Share is vital for investors as it helps them compare different companies’ profitability and make informed decisions when buying stocks. Companies with higher EPS ratios are usually considered more profitable and therefore deemed as better investments by investors.
However, one should be cautious while solely relying on EPS as a metric because it may not account for the growth potential of the company. A high EPS could also be due to one-time gains or accounting tricks, giving a skewed view of the company’s true profitability. To have a comprehensive analysis, it is essential to consider both Earnings Per Share and other financial metrics when evaluating a company’s performance.