Earnings per share (EPS) refers to the amount of a company’s profit that is allocated to each share of common stock. Timothy from Timothysykes.com says “Earnings per share gives a good idea of the company in question’s profitability. Company’s often report EPS that is altered for extraordinary items and the possibility of share dilution.”
The Formula: Net Income – Preferred Dividends/Weighted Average Common Shares
In order to calculate the EPS of a company, it’s balance sheet and income statement are examined to find a number of things – the weighted average number of common shares, returns paid on preferred stock (if existent), as well as the company’s net income/profits. Due to the chance that the number of shares can change over a period of time, it is a good idea to use a weighted average number of common shares over the reporting term. All stock dividends or splits that take place must be shown in the calculation of the weighted average number of shares outstanding.
Different Types of EPS
Basic and Diluted EPS are two different forms of the earnings per share formula. Basic EPS is an approximate measurement of the portion of a company’s profit that can be allocated to one share of its stock. Basic earnings per share does not take into consideration the fact that shares could be diluted by the company. The total number of outstanding shares that a company has in the market could increase if investments are put into place. In order to give a better picture of the effects of added financial instruments on per-share earnings, companies also provide a report of the diluted EPS. The diluted EPS assumes all shares that have the possibility to be outstanding have been issued.
Expanding on Basic EPS: earnings per share can be altered both deliberately and non-deliberately as a result of a number of factors. Analysts use different versions of basic EPS in an attempt to avoid the most prevalent ways that EPS can be inflated. These variations might include “Earnings Per Share Excluding Extraordinary Items,” or “Earnings Per Share from Continuing Operations.”
Earnings Per Share Excluding Extraordinary Items: An extraordinary item refers to a gain or loss on a company’s income statement that has resulted from an unusual/infrequent event, i.e. one which would be difficult to replicate. Shareholders/potential investors could be misguided if such an event is part if the numerator of the EPS calculation – it is therefore excluded. The formula for EPS excluding extraordinary items is:
Net Income – Pref.Div(+or-)Extraordinary Items / Weighted Average Common Shares
Earnings Per Share from Continuing Operations
An example – if a company were to start the financial year with 700 stores with an EPS of $4.00, but close 200 of these stores over the year and end with 500, it would be in the best interest of an analyst/potential investor to know what the EPS was for the company with 500 as opposed to 700, since this is what they will be moving forward with. This could be positive or negative since the EPS could decrease or increase. If an analyst wishes to compare previous performance against present performance, they are best to evaluate EPS from continuing operations. The formula from EPS Continuing Operations is:
Net Income – Pref.Div(+or-)Extraordinary Items(+or-)Discontinued Operations / Weighted Average Common Shares
The Relevance of the Earnings Per Share Formula
EPS is an extremely important factor in the determination of a share’s price. As well as this, it plays a major role in the calculation of the price-to-earnings ratio. An investor is able to see the value of a stock with regard to the amount that the market is willing to pay for each dollar of earnings by dividing the price of the company’s share by its EPS.
To summarise, EPS is established by dividing the profits of a company by the available shares. The calculation can be refined for shares that could be generated through options, convertible debt, etc, by adjusting the numerator and denominator. Examining EPS in itself may not serve a huge amount of purpose to investors since normal shareholders to not have direct access to earnings. However, comparing the EPS against the share price of the stock will allow investors to establish the value of earnings, and may influence how they feel about future growth.