One of the most commonly used financial terms, earnings per share (EPS) indicates about a company’s profitability. It breaks down a firm’s profit on per share basis and helps in calculating share price of a company. EPS is that part of the profit made by a company that is distributed to every outstanding share of common stock. Tracking company’s EPS over a period in time gives an idea if the profit and earnings surged over that time, remained static or muted. It’s best advised to apply EPS-based comparison to firms from same sector. Although many other factors should also be taken into account before calculating a profits, high EPS reflects company’s profitability.
EPS= (Net Income – Preference Dividends)/ Average Outstanding Shares
Generally, it’s advisable to use weighted average number of shares outstanding over the reporting period as the number may keep varying with time. In addition, even diluted earnings during the same period may change the capital structure of the company.
EPS= Net Income/ weighted average outstanding shares
How to calculate earnings per share (EPS)?
For example, a company Z has 400,000 outstanding shares for 8 months and as fresh 20,000 shares are issued has 420,000 outstanding shares for the remaining 4 months. The weight for 400,000 would be calculated as 8/12 = 0.67 and the weight for 420,000 shares would be 4/12 = 0.34.
0.67*400,000+0.34*420,000 = 268,000+142, 800 =410,800
It’s also observed that EPS may be same for any two firms with different number of outstanding shares. The rationale behind this is that one of the companies may have made better use of the capital to generate profits in comparison to the other.
Importance of EPS
EPS helps in determining company’s profitability.
EPS determines share price of a company
EPS is also used to calculate the price-to-earnings (P/E) valuation ratio. E here refers to EPS.
PE ratio helps an investor in understanding fair market value of a stock and take a call if that particular stock should be purchased or sold.