What is EPS?
Earnings per share (EPS) is one way to help measure a company’s profitability, by dividing how much money a company earns by the total number of shares.
Earnings per share (EPS) is just one of many tools investors have in their toolbox to analyze the health of a business and estimate its overall value. EPS is the total net profit (minus dividends paid on preferred stock, if any) divided by the total number of shares people own in that company. EPS shows how much money a company has earned for every share of stock. It helps indicate how profitable that company’s shares are compared to others -- the higher the EPS, the higher the profitability. EPS is just one tool in a hefty toolbox of other ratios that help you size up a business.
Whether you’re talking about a tech company or a carmaker, you can use EPS to judge that company’s profitability. Take Ford, for example — Its EPS over the first three months of 2019 was $0.29 per share, which is calculated by taking its net income over that period ($1.77B) minus any preferred dividends paid ($597 million), divided by the average number of outstanding common shares (3.97B), all over the same period of time. That equals $0.29 in earnings per share. (Figures pulled from Ford’s Q1 2019 earnings).
EPS is one tool to help investors get to know a stock…
Earnings per share shows what part of a company's total profits is "owned" by each individual share. Tracking a company’s EPS over time helps you assess the stock’s change in value over time.
EPS is a handy way to help gauge one key indicator of the strength of a company — profitability, aka, how good a company is at making money. EPS is a big deal for companies because it can have a notable impact on a stock’s price, which affects investors, insiders, and anyone thinking about buying up some shares.
When a stock’s EPS rises or falls, it can correlate with an increase or decrease in stock price. This is because a higher EPS indicates the company is making more money. If EPS falls, it suggests profit is shrinking.
Tracking EPS is one of many ways to pull out your magnifying glass and look closely at a company’s future growth — in any direction. A steadily rising EPS, for example, suggests a company is becoming more profitable (better at making money) over time, while a stagnant EPS or a declining EPS could signal that a company’s glory days are behind it.
Keep this in mind: Just because an EPS rises or falls, doesn’t necessarily mean the company is doing better or worse. Similarly, if one company’s EPS is higher than another’s, it doesn’t guarantee that that company is better at making money. That’s because it’s possible for EPS to change simply because a company’s total number of shares on the market increases or decreases. If more shares become available, but the company’s earnings (also called “net income”) stay the same, its EPS will get smaller. Similarly, if the number of shares decreases, or a company buys back more of its own shares and its earnings remain the same, the EPS becomes larger. Neither of these changes in EPS, though, were the result of a change in the company’s ability to turn a profit.
In the EPS equation, the numerator — earnings — comes from a company’s earnings report, which is like a report card that comes out once a quarter or once a year. (If EPS is calculated using yearly metrics, it’s called an “annual EPS”).
The denominator — the total number of outstanding shares — can be found in two main ways. First, the total share count can be pulled from a company’s financial statements, like the income statement, at the end of a specific period of time. However, because the total number of shares can change at any point in time, a second, more accurate way to account for the number of shares is to calculate the weighted average of shares outstanding over a period of time, instead of simply using the final number at the end of a financial period. This average results in a more accurate tally, and a more precise final EPS figure.
Whether you use the first or second way of tallying shares, you can account for events that change share count, like stock dividends, stock splits, stock issuance, or stock buybacks to get a more accurate final tally.
The three main versions of EPS are all like pieces of a profit pizza, but they’re sliced in slightly different ways:
Basic EPS: This is your most straightforward EPS calculation. Like all EPS varieties, the numerator (the top number), is calculated by taking the company’s total net profit and subtracting any dividends paid to shareholders who own preferred common shares (aka “preferred dividends). The denominator (bottom number), is either the total number of outstanding shares at the end of a specific period of time, or an average number of outstanding shares over a period of time. Basic EPS keeps things simple.
Diluted EPS: Diluted EPS uses the same numerator (total net profits minus preferred dividends) as basic EPS. But, diluted EPS gets more in the weeds in the denominator. Instead of simply taking the total number of outstanding shares or the average total number of outstanding shares, diluted EPS uses a more detailed calculation for share count, that usually results in a higher denominator — And a bigger denominator means a smaller EPS. Diluted EPS can account for additional shares, which at some point, could also become common stock, but aren’t yet. This can include stock options, preferred shares (shares that typically come with voting power and are owned by insiders), restricted stock units, and more. Adding these shares to the total number of outstanding shares increases the denominator, and results in a more conservative EPS amount.
Adjusted EPS: While diluted EPS is all about fine-tuning the denominator, adjusted EPS hones in on the numerator. Adjusted EPS tends to use the same denominator as basic EPS (the total number or average number of outstanding shares over a period of time), but accounts for more factors in the numerator (net income), to offer a more realistic sense of a company’s day-to-day business performance. An adjusted EPS could take into consideration large one-off profit gains or losses that aren’t reflective of the core business. For example, if a tech company makes a significant profit from selling a piece of real estate, adjusted EPS can exclude that profit from the numerator, because it doesn’t reflect how the core tech business (selling software) is really doing. Similarly, if a large retail chain is about to close 20 stores, adjusted EPS could exclude the earnings from those stores from the numerator (net income), knowing that those stores won’t be generating any sales in the future.
The Bottomline Basic EPS is your quick calculator for a company’s profit per share. Diluted EPS and adjusted EPS incorporate more metrics in the denominator and numerator of the EPS equation respectively. That usually produces a more conservative EPS figure that can better reflect how the company might look in the future.
EPS is a useful tool, but it has its limitations. A key figure to incorporate when calculating the profitability or valuation of a company (how much it’s worth), is capital — how much funding a company used to run a business and generate its earnings. If two companies generate the same earnings, one company is still likely more efficient than the other, based on how much capital each company uses to run its business. The amount of profits a company is able to wring out of a given amount of capital is called Return on Capital, which is another performance metric in the investor toolbox.
EPS and price-to-earnings ratio (PE ratio) are two different tools in your valuation toolbox that can be used to help assess the health of a company and its potential to grow down the line. They’re a bit like Russian nesting dolls. EPS is actually a component of the PE ratio, which is a ratio that’s found by dividing a company’s share price by its EPS.
What’s a PE ratio good for? It’s basically a way of measuring how much an investor is willing to pay for each dollar of earnings, and it can be a strong signal as to whether a company is on track for growth or decline. Stocks with higher PE ratios could signal that investors expect that company to see major growth down the line, even if it isn’t good at making profits right now. Similarly, companies that aren’t expected to have another growth spurt tend to have lower PE ratios.
EPS and the PE ratio are both linked to a company’s earnings report (its official financial report card). While strong earnings can help boost the individual earnings component of each ratio, great earnings can also drive up the price per share. Likewise, weak earnings can lower the earnings component and drive down a stock.
Dividends are a portion of a company’s profits that get doled back to shareholders, kind of like getting a check from grandma in the mail. Meanwhile, the earnings embodied through the EPS metric aren’t directly available to shareholders. The company holds on to the value of the earnings represented in earnings per share, so that it can accumulate cash and resources with the aim of running a sturdy business. After profits are made by the company, its management has a number of things it can do with them, one of which is sending dividends to shareholders.
Disclosure: Stocks referenced in this article were chosen from our list of the 100 most popular stocks on the Robinhood app.
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