Earnings per share (EPS) is a financial ratio that divides a company's net earnings by the average number of outstanding shares available to its common stock. A company can use the resultant figure to evaluate its profitability. It is customary for companies to publish EPS that has been adjusted for unique products and possible share dilution. A company with its more extraordinary EPS has significant profitability.
Earnings Per Share Formula
EPS can be calculated using the following formula:
Because EPS relates to earnings open to the common shareholder, the preferred dividends for the current year are deducted from net income. Dividends on common shares are not deducted from net income.
How to Calculate Earnings Per Share (EPS)
You can calculate the EPS of a company using an income statement and balance sheet that determine the number of common shares outstanding at period-end, dividends paid on preferred stocks, and net earnings or income. Because the number of common shares can fluctuate over time, it is more accurate to utilize a weighted average for the reporting period.
The weighted average calculates EPS since the number of outstanding common shares may fluctuate over a year. The weighted average number of common shareholders refers to the number of common outstanding shares for the year, weighted based on the year they were outstanding.
Some data sources may make the calculation easier by utilizing the total amount of outstanding shares at the end of a particular period.
You can calculate the weighted average number of outstanding common shares in three steps:
Determine the common share balance at the start of the year and any modifications that have occurred.
- After each adjustment to the common shares, determine the number of outstanding shares. The number of outstanding shares rises due to the release of new shares and decreases as a result of share repurchases.
- Divide the number of outstanding shares by the months remaining in the year.
- Add everything up to determine the average number of outstanding common shares.
Basic EPS Vs. Diluted EPS
Unlike the "basic" earnings per share (EPS), diluted EPS figures consider all possible outstanding shares. The outstanding share count must be multiplied by financial instruments, such as convertible debt or equity and employee stock options, that are frequently utilized to raise funds and encourage workers.
For example, let's figure out Netflix's diluted EPS. The number of currently outstanding shares has increased to 454,208,000 due to the corporation issuing 13,286,000 common stock options to employees. The same $2,761,395,000 in net income is divided by 454,208,000 to produce an EPS figure of $6.08.
Fully diluted EPS is used in valuation models as it is more conservative. Share counts typically rise, particularly for rapidly expanding businesses that take advantage of their ability to issue more shares to grow.
How to Use Earnings Per Share (EPS)
The best use of EPS data is when it is compared to other indicators. The price/earnings (P/E) ratio, which contrasts a firm's stock price to its return on equity (ROE), and earnings per share (EPS), which shows how much profit a company makes from its net assets, are the two most popular metrics.
Earnings Yield: The earnings yield refers to the proportion of earnings per share (EPS) of a company. You can calculate this by inverting the P/E ratio.
Price-to-earnings-growth ratio (PEG ratio): PGE ratio is a modified version of the P/E ratio that involves the basic earnings per share (EPS) and adjusting for the expected annual growth in EPS over the coming years.
How Can you use Excel to Calculate EPS?
Enter the preferred dividends, net income, and the number of outstanding common shares into 3 adjacent cells, let's say B3 through B5, after gathering the appropriate information. Use the calculation "=B3-B4" in cell B6, subtracting preferred dividends from the net earnings or income. Enter the formula "=B6/B5" to calculate the earnings per share ratio" in cell B7.
Limitations of Earnings Per Share (EPS)
The biggest drawback of using EPS to assess a stock's or company's value is that it is derived from net income.
Non-cash costs like depreciation reduce net income. A company's net income may vary significantly between reporting periods because capital expenditures are lumpy.
Non-operating costs for businesses, such as interest payments and tax, can vary greatly and have an impact on net income.
Net income does not fully reflect the health of a company's operation and cash flow.
Additionally, companies can modify their EPS figures by altering the number of outstanding shares.
The weighted average of common shares changes as a result of share issuances, splits, and stock buybacks.
Bottom line
An essential profitability metric for comparing the price of a stock to a business's actual earnings is earnings per share (EPS). Generally, a larger EPS is preferable, but it's essential to consider the number of outstanding shares, the possibility of share dilution, and long-term profit trends. A company's stock may decline or increase depending on whether it meets or exceeds analysts' consensus forecasts for EPS.