What is Earnings Per Share (EPS)?
Earnings per share (EPS) is a financial metric used to calculate the amount of profit a company makes on each share of common stock. EPS is calculated by dividing a company’s net income by the number of shares of common stock outstanding. Investors use EPS to assess and compare companies’ performance before investing in them.
The higher the EPS, the more profitable a company is for investors. EPS may be adjusted for extraordinary items and potential share dilution.
How to calculate EPS
Earnings per share (EPS) is one of the most important metrics that investors look at when analyzing a company. The calculation is simple: net income divided by the number of shares outstanding. This figure is usually a weighted average, taking into account different types of shares such as common stock, preferred stock, and warrants.
However, there are a few things to keep in mind when calculating EPS.
First, you need to find net income, which is simply gross profit minus operating expenses and taxes. Then, you need to subtract any dividend payments made during the period, giving you the company’s net profit.
The last thing to consider is that companies often issue more shares to expand their business operations. When this occurs, fully diluted EPS becomes more conservative than net income because the share count tends to increase.
Example:
Here’s an EPS computation using Netflix (NASDAQ: NFLX) as an example. The business declared a total income of $2,761,395,000 in its fiscal year with total outstanding shares of 440,922,000.
Netflix has not issued preferred shares, so we do not need to deduct preferred dividends. Divided by 440,922,000, $2,761,395,000 equals a $6.26 EPS.
Calculating EPS with Excel
After gathering the appropriate data, insert the net income, preferred dividends, and number of outstanding common shares in three adjacent cells, say B3 through B5. Subtract chosen dividends from net income using the method “=B3-B4” in cell B6. To calculate the EPS ratio, enter the formula “=B6/B5” in cell B7.
EPS limitations
Earnings per share, or EPS, is one of the most commonly used metrics to measure a company’s financial performance. EPS is essential because it reflects how much money each share in the company makes.
However, there are several limitations to using EPS as a metric.
First, EPS is calculated solely on net income, so non-cash expenses are subtracted from that number. This can create lumpy capital expenditures that can cause a company’s EPS to vary significantly across periods. Additionally, EPS numbers are most valuable when evaluated with other data. For example, if you compare a company’s EPS to its revenue or operating profit, you can see its financial performance.
Additionally, non-operating expenses, such as tax and interest payments, can affect net income and thus EPS.
EPS numbers can also be manipulated by changing outstanding shares or conducting share issuances, splits, or stock buybacks. Therefore, it is crucial to be aware of these factors when evaluating a company’s EPS number.
What is an acceptable EPS?
There is no definitive answer to this question. A good EPS can vary depending on the industry, the company and individual circumstances.
The answer depends on several factors, such as recent performance, competitors’ performance, and analysts’ expectations. Generally speaking; however, a company with a high EPS is considered to be doing well.
On the other hand, if a company’s EPS is lower than expected or worse than its competitors’, its stock price might decrease. This is because investors will expect the company to make less money in the future.
It’s also important to keep in mind that the absolute value of a company’s EPS shouldn’t change too much from year to year, but the annual growth rate should. This indicates whether or not the company is making more or less money each year.
A company can boost its EPS by increasing its earnings or reducing its share count through share buybacks; however, if it increases its outstanding share count faster than its earnings, its EPS will drop.
As you can see, there are many things to consider when looking at a company’s EPS figure. But overall, it provides a good snapshot of how well the business is doing financially.
Basic vs. diluted EPS
There are two types of EPS: basic and diluted. Basic EPS does not factor in the dilutive effect of shares that could be issued by a company, while diluted EPS takes into account all potential shares that could be issued. To calculate diluted EPS, you need to know the number of common shares outstanding, the number of convertible preferred shares outstanding, and the number of warrants and options outstanding.
When a company has more than one type of security, it can issue more shares to investors than the number of shares outstanding at any given point in time. This is done through stock options, warrants, and restricted stock units (RSU). For example, if a company has 10 million shares outstanding and issues 1 million options, then the company could give 11 million potential shares. The total number of potential shares is called the “dilution potential.”
The diluted EPS calculation considers all of the potential securities that could be issued and converts them to actual shares. This calculation gives a more accurate representation of how earnings would be diluted if all the likely securities were exercised.
The diluted EPS calculation is necessary because it shows how the earnings per share would be affected if all the additional securities were converted into common stock. It also allows companies and analysts to avoid distortion when adding convertible debt interest back into a diluted EPS calculation numerator.
Difference between EPS and adjusted EPS
The main difference between EPS and Adjusted EPS is that Adjusted EPS takes into account one-time events or items that would otherwise distort a company’s earnings. EPS is calculated by taking its net income and dividing it by the number of shares outstanding. Adjusted EPS, sometimes referred to as recurring EPS, is calculated by taking the company’s net income and dividing it by the number of shares outstanding, minus the effects of one-time events or items.
This typically consists of adding or removing components from net income that have been deemed non-recurring and are not expected to occur again in the foreseeable future.
The main difference between these two calculations is that basic EPS does not consider one-time profits and expenses, while adjusted EPS does. Adjusted EPS is, therefore, a more accurate representation of a company’s earnings performance because it removes items that are not considered representative of its normal operations.
EPS and price to earnings
Comparing P/E ratios inside an industry group can be beneficial, albeit in unexpected ways. While a stock that is more expensive in relation to its earnings per share when compared to rivals may be “overvalued,” the opposite is typically true.
Shareholders are willing to pay extra for a stock regardless of its previous earnings per share if it is predicted to expand or beat its peers. It is natural for the stocks with the greatest P/E ratios in a stock market index to outperform the index’s average.
