What exactly is EPS (Earnings Per Share)?
The profit of a corporation is divided by the number of outstanding shares of its common stock to arrive at earnings per share (EPS). The resultant figure is used to gauge a company's profitability. It is typical for businesses to publish EPS that has been adjusted for unusual expenses and possible share dilution.
The more profitable a corporation is deemed to be, the greater its EPS.
Defining the EPS formula
The formula divides the company's net income by the number of outstanding shares to arrive at EPS. The amount of money the business has remaining after paying its expenses is known as net income, which is often referred to as profits or earnings.
The equation is as follows:
Earnings per share = net income – preferred dividends/end-of-period common shares
You must locate the common shares, stock dividends paid, and net income on the company's balance sheet and income statements in order to determine the EPS. Given that the number of shares can change over time, the best way to obtain the most precise information is to determine the weighted number of shares for that reporting period. As we'll examine in more detail, many corporations also incorporate other items like sizable gains or losses and potential share dilution.
Actual Earnings Per Share
You can obtain a more precise computation by utilizing the weighted average number of shares because the number of outstanding shares can change throughout the course of the year. The weighted shares can be calculated using these steps.
Step 1: After each change in common shares, ascertain the number of outstanding shares. This can involve increasing the number of shares by issuing new ones or decreasing the number of outstanding shares by repurchasing shares.
Step 2: Divide the number of outstanding shares by the interval between changes.
Step 3: Add up the weighted average number of outstanding shares.
Let's use Company X as an example, with a net income of $1,000,000 and no shares of preferred stock outstanding. Throughout the year, they had 50,000 outstanding shares. According to the computation, the company's EPS is $2 (1,000,000 - 0) / 500,000 = $2.0.
Good EPS ratios
Are high profits per share ratios good, you may be wondering. What EPS ratio would be ideal?
The term "good" EPS in the context of equities refers to a number of different things. These consist of the recent performance of the business, that of its rivals, and the stock price projections of analysts. As a general rule, a corporation is more likely to be profitable the higher its EPS. However, as we are all too well, there is no assurance that an investment will perform well in the future.
It's crucial to remember that a company's reporting of costs and profits might affect how reliable the EPS is, therefore spotting accounting adjustments can help ascertain EPS accuracy.
Comparing ratios of Earnings Per Share
When buying companies, comparing EPS ratios might be a useful signal. When a company's EPS increases consistently over time, it may indicate that it can continue to be profitable. On the other hand, declining EPS figures may indicate that the business is experiencing a loss.
When evaluating a company's financial health, the price-to-earnings ratio (P/E ratio) should also be taken into account in addition to earnings per share (EPS). A greater P/E ratio could mean that higher earnings are anticipated or even that the company is overvalued. You will have a clearer understanding of a company and its financial health the more study is conducted and the metrics are used in data collection.
Additional EPS variants
The term "basic" EPS refers to the widely used EPS computation. In addition, there are a few further types, such as:
- Diluted EPS – considers the company’s convertible securities.
- Continuing operations EPS – only includes daily operations and not any discontinued operations, accounting alterations, or extraordinary items.
- EPS excluding extraordinary items – account for gains or losses on large assets.
Diluted EPS vs. Basic EPS
The basic EPS of each of these chosen companies is determined using the formula in the above table. Basic EPS does not account for the potential dilution from stock issuance by the corporation. Stock options, warrants, and restricted stock units (RSU) are examples of capital structure elements that, if exercised, could raise the total number of shares outstanding in the market.
Companies also publish the diluted EPS, which makes the assumption that all shares that could be outstanding have been issued, in order to more clearly show the effects of new securities on per-share earnings.
For the fiscal year that concluded in 2017, for instance, the total number of shares that could be formed and issued from the convertible instruments of NVIDIA was 23 million. Its diluted weighted average shares outstanding will be 541 million + 23 million = 564 million shares if this amount is added to the number of shares that are now outstanding. Therefore, the company's diluted EPS is $1.67 billion divided by.564 million, or $2.96.
When calculating a fully diluted EPS, the numerator must occasionally be changed. For instance, in some circumstances, a lender may offer a loan that enables them to convert the debt into shares. The convertible debt's shares should be counted toward the diluted EPS calculation's denominator, but if that were to happen, the corporation wouldn't have had to pay interest on the loan. In order to prevent the calculation of EPS from being manipulated, the company or analyst will in this situation add the interest paid on convertible debt back into the numerator.
EPS from Continuing Operations
A business had 500 stores and an EPS of $5.00 at the beginning of the year. But suppose this business closed 100 stores during that time, leaving it with 400 by the end of the year. An analyst will be interested in the EPS for just the 400 stores the business intends to operate through the upcoming quarter.
Because the 100 shuttered stores in this scenario may have been at a loss, it might raise the EPS. An analyst is more effectively able to contrast past performance with current performance by measuring EPS from ongoing operations.
EPS Excluding Extraordinary Items
Several factors have the potential to purposefully or accidentally affect earnings per share. To avoid the most typical ways that EPS may be overstated, analysts employ modifications of the fundamental EPS calculation.
Think of a business that operates two facilities that produce cellphone screens. One of the factories is located on land that has increased in value due to the recent surrounding construction. The management team of the business chooses to sell the factory and erect a new one on less expensive property. The business makes a windfall profit as a result of this deal.
Although the company and its shareholders have really benefited from this property sale, it is still regarded as an "exceptional item" because there is no indication that the business will be able to duplicate the transaction in the future. If the windfall was factored into the EPS equation's numerator, shareholders might be misled, so it was left out.
If a corporation experienced an exceptional loss—say, a factory fire—which would have temporarily reduced EPS and should be disregarded for the same reason, one could make a similar case.
How EPS is used
When performing financial analysis, basic and diluted EPS are used to determine whether an investment is worthwhile for a particular investor. The easiest way to assess a company's financial success is to compare its earnings per share over many reporting periods.
When a corporation converts assets to common shares, which happens sometimes, you can utilize diluted EPS to assess what might happen. Other financial statistics that aid in further firm evaluations includes:
- P/E ratio: If a company is selling at $30 and its basic EPS for the year is $3.20, the firm's P/E ratio is roughly 9.4. This informs you that, if everything else remained the same, it would take more than nine years to earn back the $30 invested in the stock.
- Earnings Yield: The earnings yield, or proportion of a company's earnings per share, can be calculated by inverting the P/E ratio.
- PEG Ratio: The price-to-earnings-growth ratio (PEG ratio) modifies the P/E ratio by using the fundamental EPS and accounting for the expected annual growth in earnings per share.
- Dividend-Adjusted PEG Ratio: The price/earnings to growth and dividend yield ratio (PEGY), a variant of the PEG ratio, takes basic EPS and takes into consideration both the dividend yield and the predicted growth in future earnings per share.
Capital and EPS
The capital needed to produce the earnings (net income) in the computation is a crucial component of EPS that is sometimes overlooked. One firm may be more effective at using its capital to generate revenue than another, and, all other things being equal, would be the "better" company in terms of efficiency. Two companies may generate the same EPS, but one may be able to do it with fewer net assets. The return on equity (ROE) is a measure that can be used to determine which businesses are more effective.
Dividends and EPS
Shareholders do not have immediate access to a company's profits, despite the fact that EPS is frequently used to monitor a company's success. A portion of the profits may be paid out as a dividend, but the corporation may choose to keep all or a portion of the EPS. To gain access to more of those profits, shareholders would have to adjust the percentage of EPS that is given through dividends, through their representatives on the board of directors.
Price-to-Earnings (P/E) and EPS
Although in unexpected ways, comparing the P/E ratios within an industry sector might be useful. Although it could appear that a stock that is more expensive relative to its EPS when compared to its competitors is "overvalued," the opposite is more often the case. Investors are willing to pay more for a stock if it is anticipated to grow or beat its competitors, regardless of its historical earnings per share. In a bull market, it is typical for the companies in an index with the highest P/E ratios to do better than the index as a whole on average.
What's the final take?
Before making an investment, it's crucial to assess a company's financial position, and calculating the EPS might provide useful data. To make sure your entire evaluation of the company aligns with expectations for performance and profitability, it's also crucial to employ extra factors like P/E ratios and other valuation techniques.
FAQ
What are the limitations of EPS?
Even while EPS is a crucial financial indicator for assessing a business's financial performance, on its own, it doesn't provide investors with much information about a firm due to variations in corporate accounting and reporting practices. Although public firms present their financial information in the same way, not all of them use the same internal accounting procedures.
Does a 'good' EPS exist?
What constitutes a decent EPS will vary depending on a number of variables, including the company's most recent performance, that of its rivals, and the forecasts of stock market analysts. When a company reports an increasing EPS, the stock price may occasionally fall if analysts had anticipated a higher figure.
Likewise, if analysts were anticipating a worse outcome, a declining EPS figure can nevertheless result in an increase in price. Always evaluate EPS in relation to the share price of the company, for example, by checking the P/E ratio or earnings yield.
Is EPS more important than revenue?
EPS more accurately depicts a company's theoretical value per share, which cannot be determined solely from revenue figures.
What does it mean if the EPS is negative?
When a company's income is negative, which indicates that it is losing money or spending more than it is bringing in, earnings per share might be negative. A stock's negative EPS does not automatically indicate that it is a sell.
What is a good EPS growth rate?
A healthy EPS growth rate is over 15%, as was previously stated, and is typically accompanied by a greater sales growth rate.