When investing in stocks, it’s not only important to understand your investment goals and risk tolerance, but it’s also important to do research on the companies you’re investing in. A common method used by investors to assess a companys profitability is known as EPS.
So, what does EPS stand for, and how can it support your investment goals? Let’s explore how to calculate EPS and everything you need to know about this essential financial metric.
Earnings per share (EPS) is a dollar value that represents a public company’s profit in a given period.
In simple terms, it shows how much money a company makes for each share you own. When you’re analyzing a stock, EPS may give you a quick snapshot of the company’s financial health and profitability on a per-share basis.
As part of a quarterly or annual earnings report, a company calculates its profit (aka earnings) per share. EPS results can contribute to an investors decision to buy, sell, or hold.
EPS meaning Earnings per share (EPS) measures how much money a company earns from each of its shares of stock and is used by investors to assess the company’s profitability.
EPS is calculated by dividing the net profit by the number of outstanding shares.
Diluted EPS accounts for a company’s convertible securities, which could potentially dilute the number of shares.
EPS is a key metric that may help you determine a companys profitability. A high EPS generally signals a profitable company, while a lower EPS might indicate financial struggles. Here’s why EPS should matter to you:
Read More: How to read an earnings report?
EPS is calculated by dividing a companys net income (after taxes) by its total outstanding shares. Here’s the formula:
EPS: Net income – Dividends on preferred stock / Average outstanding shares
The number of shares outstanding can be a simple average or a weighted average, depending on the accounting methods used.
For example, if a company has a net income of $10 million and 5 million shares outstanding, its EPS would be $2.00.
Because the number of outstanding shares can vary during the year, you can get a more accurate calculation by using the weighted average number of shares. These steps can be used to calculate the weighted shares.
For example, lets say Company X had a net income of $1,000,000 this year with no outstanding preferred stock shares. They had 50,000 shares outstanding during the year. The calculation would read: (1,000,000 0) / 500,000 = $2.0, meaning the companys EPS equals $2.
There are various types of EPS that investors and analysts may focus on. Each offers a different perspective on a company’s profitability:
Basic EPS simply divides net income by the total outstanding shares. However, it doesnt account for potentially dilutive securities, like stock options or convertible debt, which may increase the number of shares.
Diluted EPS includes the impact of potential share dilution from securities such as stock options or convertible bonds. If a company has dilutive securities, this measure shows you a more conservative EPS.
Diluted EPS = Net Income Preferred Dividends / Weighted Average Shares Outstanding + Dilutive Securities
Trailing EPS refers to the EPS calculated using data from the previous 12 months. This figure may provide you with a historical view of the company’s earnings.
Forward EPS uses analyst predictions or company guidance to estimate future profitability. This may give you an idea of expected performance, although it’s not as reliable as actual earnings.
EPS may play a significant role in influencing stock prices, especially around earnings season when companies report their financial results. If a companys reported EPS is higher than expected, you’ll may see its stock price rise due to positive investor sentiment. Conversely, a lower-than-expected EPS may lead to a drop in stock price.
EPS is also essential when calculating the P/E ratio. Dividing the stock price by EPS gives you this popular metric, which shows whether a stock might be overvalued or undervalued:
You might be wondering if a high earnings per share ratio is good. What’s an ideal EPS ratio?
Several factors need to be taken into account to define a good EPS in stocks. Those include the companys recent performance, the competitors performance, and analysts expectations of the stock. As a rule of thumb, the higher a companys EPS, the more likely it is to be profitable. Still, as we well know, theres no guarantee of performance in the future when it comes to investing.
It’s important to note that how a company reports expenses and earnings can manipulate the reliability of the EPS, so identifying accounting changes can help determine EPS accuracy.
Comparing EPS ratios can be a helpful indicator when investing in stocks. When a companys EPS shows continued growth over time, it can be a good sign that it’s able to maintain profitability. On the other hand, when you see dropping EPS numbers, it can be a sign the companys losing money.
In addition to EPS, another factor to consider when looking at a companys financial health is the price-to-earnings ratio (P/E ratio). A higher P/E ratio may indicate expected higher earnings or possibly suggest the company is overvalued. The more research is done and the metrics used in gathering data, the clearer picture you will get of a company and its financial health.
When reviewing a companys income statement, knowing the difference between EPS and diluted EPS can help determine the calculation you’ll want to use to get the most accurate information. Basic EPS doesnt account for additional stock options or warrants, which, if exercised, may increase the stock shares that are outstanding in the market.
This means that youll want to evaluate the business as a whole, how profitable it is, and the profits per share, since each share of stock represents ownership in that company.
To review, the basic formula for EPS is:
Earnings per share = Net income – Preferred dividends / End-of-period common shares
For comparison, the diluted EPS formula is:
Diluted earnings per share = Net income – Preferred dividends / Total weighted average # Shares + Other dilutive securities
Investors interested in dividends will likely want to use the diluted EPS calculation. However, the reality is that despite a companys profits, shareholders may not receive much per share, which isnt great for investors who want to invest to receive dividends, so using the correct formula gives them a better idea of what to expect.
There are a few reasons shareholders may not see profits (diluted). For example, a merger with new shares being issued or vesting periods coming to an end can dilute a stock.
EPS can fluctuate due to a variety of factors, including:
While EPS is useful, it’s not perfect. Here are some limitations you should keep in mind:
EPS does not directly account for a companys debt levels. A company with high EPS might also have significant debt, which could pose a risk to its financial health.
EPS can be influenced by accounting adjustments, stock buybacks, or one-time gains or losses, which might not accurately reflect a companys ongoing operational performance.
EPS is based on net income, which can differ from cash flow. A company might report high EPS but have weak cash flow, which could indicate issues with liquidity.
It’s an important step to evaluate a companys financials before investing, and calculating the EPS can offer helpful information. That said, it’s also important to use additional parameters such as P/E ratios and other valuation methods to ensure your overall assessment of the company matches expectations for performance and profitability.
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The EPS figure can help investors gain insight into a company’s profitability. Generally, the higher the number, the more profitable the company is, and the more investors want to own the stock, which may result in higher stock prices.
No. EPS calculates the profitability of a company, and dividends are the money paid to shareholders.
A negative EPS can indicate that a company’s spending more than its earning or losing money, so other metrics should be considered when evaluating a company’s financial statements.
