Earnings Per Share (EPS)

Overview

Earnings Per Share (EPS) is the total amount of earnings attributed to each individual share over a period of one year. It is a way of measuring the profits made by the company for each share outstanding.

Formula

Calculation: The formula for calculating EPS uses the net income of the company and subtracts the preferred dividends paid. This gives us the earnings available to common shareholders, which is then divided by the number of shares outstanding to get earnings per share.

Why Subtract Preferred Dividends: Since dividends payable to preferred shareholders are not available to common shareholders, they are deducted from the calculation of EPS. EPS represents the earnings attributable specifically to common stock holders, so preferred dividends must be excluded.

Calculation Example

Let's calculate the earnings per share for a hypothetical company to demonstrate the process:

How to Interpret

EPS can be interpreted in two different ways depending on which type of EPS is being reported: Basic EPS and Diluted EPS. Understanding the difference between these two types is crucial for accurate analysis.

Basic EPS vs Diluted EPS:

Which to Use: Investors should pay attention to both Basic and Diluted EPS. Basic EPS shows current profitability per existing share, while Diluted EPS shows the worst-case scenario if all dilutive securities are converted. A large difference between Basic and Diluted EPS indicates significant potential dilution from convertible securities, which could reduce future earnings per share for existing shareholders. Most financial analysts and investors focus on Diluted EPS as it provides the more conservative and realistic measure of profitability.

Why It Matters

Earnings growth and future earnings potential are one of the most important factors for investors. EPS and EPS growth serve as key proxies for evaluating company performance and investment potential.

Key Insights:

• Profitability Measurement: EPS is a way of measuring the profits made by the company for each share outstanding. It normalizes earnings to a per-share basis, allowing investors to easily understand and compare profitability across companies of different sizes. A company with $10 million in earnings and 1 million shares (EPS = $10) is more profitable per share than a company with $20 million in earnings and 5 million shares (EPS = $4), even though the second company has higher total earnings.
• Company Performance Proxy: Earnings growth and future earnings potential are one of the most important factors for investors. A lot of investors use EPS and EPS growth as a proxy for estimating how well a company is doing. Growing EPS signals improving profitability and operational efficiency, while declining EPS may indicate business challenges. EPS trends provide a quick snapshot of whether the company is becoming more or less profitable over time on a per-share basis.
• Investment Quality Indicator: A company that is able to grow its EPS year over year is considered a good investment. This consistent EPS growth is commonly reflected in the rise in the share price, as investors are willing to pay more for stocks with improving profitability. Companies demonstrating sustained EPS growth over multiple years are often viewed as higher-quality investments with strong management, competitive advantages, and solid business fundamentals.
• Stock Valuation Foundation: EPS is a critical component of stock valuation metrics, most notably the Price-to-Earnings (P/E) ratio. P/E ratio = Stock Price ÷ EPS, making EPS the denominator that determines whether a stock is trading at a high or low valuation multiple. Higher EPS means a lower P/E ratio (assuming price stays constant), indicating the stock may be more attractively valued. Investors closely monitor EPS when assessing whether a stock is overvalued or undervalued relative to its earnings power.

Key Takeaways

• Earnings Per Share (EPS) is total amount of earnings attributed to each individual share over period of one year
• Way of measuring profits made by company for each share outstanding
• Formula: Earnings per Share (EPS) = (Net Income − Preferred Dividends) ÷ Shares Outstanding
• Preferred dividends subtracted because not available to common shareholders
• EPS represents earnings attributable specifically to common stockholders
• Two types of EPS: Basic EPS and Diluted EPS
• Basic EPS does not account for diluting securities, uses only current common shares outstanding
• Diluted EPS accounts for diluting securities while Basic EPS does not
• Diluting securities are financial instruments that can be converted or increase common shares outstanding
• Examples of diluting securities: convertible bonds, preferred shares, stock options, warrants
• Diluted EPS important because accounts for all potential dilution from convertible securities
• Diluted EPS shows what EPS would be if all convertible securities exercised (worst-case scenario)
• Diluted EPS always equal to or lower than Basic EPS
• Most financial analysts focus on Diluted EPS as more conservative and realistic measure
• Earnings growth and future earnings potential are most important factors for investors
• Investors use EPS and EPS growth as proxy for estimating how well company doing
• Company able to grow EPS year over year considered good investment
• Consistent EPS growth commonly reflected in rising share price
• EPS normalizes earnings to per-share basis allowing comparison across companies of different sizes
• EPS critical component of Price-to-Earnings (P/E) ratio for stock valuation