EPS Formula: Earnings Per Share Calculation

One of the key concepts in any stock market investment journey is earnings per share or EPS. EPS is an important financial metric used to determine a company’s profitability. Earnings Per Share (EPS) are estimated by dividing the company’s net profit by the number of outstanding common shares.

Earnings per share is calculated with the help of a formula, called the EPS formula. The earnings per share calculation is as follows:

EPS= Net income – Preferred dividends / weighted average number of shares outstanding

From the EPS formula above, you can surmise that preferred dividends have been subtracted from net income. The reason for this is that EPS is a measure of income that is available to the common stockholder. The preferred dividends are kept apart for preferred shareholders. Preferred holders are those who are risk-averse and get prioritised over common shareholders when dividends have to be.

EPS indicates how much the company makes for each share of its stock. Investors use EPS to assess a company’s financial health and compare it to other companies in the same industry.

EPS indicates how much the company makes for each share of its stock. Investors use EPS to assess a company’s financial health and profitability as well as to compare it with peer companies from the same industry.

So, if a company had a net income of Rs 20 billion and stock dividends preferred are Rs 2 billion, and outstanding common shares were at 10 billion. The company’s earnings would be Rs 20 billion – Rs 2 billion = 18 billion. Applying the earnings per share formula to this, the company would have an EPS of Rs 18 billion / 10 billion = Rs 1.8.

Diluted earnings per share

There is also another calculation called the diluted earnings per share. This diluted EPS formula is as follows:

Diluted EPS = Net income – dividends on preferred stocks/average outstanding shares + diluted shares.

The diluted EPS factors in securities that are convertible. These securities may include preferred shares or options, for example. Diluted shares are the overall shares a company owns at a specific point that could be converted into regular shares. When these are converted into shares, the company’s earnings per share comes down.

While EPS takes into account only common shares of a company diluted EPS considers all convertible securities.

Types of EPS

Having learnt the earnings per share calculation, the next step would be to get an idea of the types of earnings per share. Some of them are:

Ongoing EPS: The ongoing earnings per share calculation is made by taking into account the net income that is current and discounts one-off events. The purpose of this type of EPS is to understand a company’s earnings via its core business. This helps in gauging income in the future.
Adjusted EPS: This is also called the ‘headline’ earnings per share and shows profits or losses that have come through the operations that are not at the ‘core’ of the business.
GAAP or reported EPS: Here, the earnings per share formula applied is based on principles of accounting also called GAAP (generally accepted accounting principles).
Trailing EPS: This is an earnings per share calculation wherein the earlier year’s number is taken into account. The trailing EPS uses the earnings of the earlier four quarters and uses real numbers rather than projections.

Earnings per share is important because it indicates whether a company’s finances are in good shape.
Typically, traders use EPS to judge a company’s health. They also compare the EPS of two firms in the same sector/industry. A high EPS would mean the firm is profitable to a measure and is capable of paying out more to shareholders.
Earnings per share helps an investor understand not just the financial position of a company at the current time but also monitor its past performance. If a company has consistently shown a growing EPS, it is indicative of an appropriate investment possibility. If companies show EPS that is dropping or inconsistent over a period of time, they may not be a choice by investors.
Earnings per share is also a key variable when it comes to computing the value of a stock. EPS comes into the picture when the price-earnings valuation ratio (P/E ratio) is calculated. The EPS figures in the earnings variable of the P/E ratio.

What Is a Good EPS?

EPS that qualifies as good EPS value varies based on several factors, including the industry, company size, and market conditions. As a general rule of thumb, a higher EPS indicates the company is more profitable. However, it is not a guarantee of good performance. One must also consider the context.

While comparing a company’s EPS, you must consider its historical performance, industry peers, and market expectations for a realistic assessment. Additionally, considering the sustainability and consistency of earnings growth is vital.

A company with growing EPS is often considered more profitable. But like with other financial metrics, it is critical to analyse EPS in conjunction with other financial metrics and fundamentals for a comprehensive understanding of a company’s financial health and prospects.

What Is the Difference Between Basic EPS and Diluted EPS?

The basic EPS estimates the earnings per share by dividing the net profit by the total outstanding shares. It takes into account all shares available for trading.

Diluted EPS is a more scientific measure of a company’s profitability because it also considers all convertible bonds and preferred stocks.

Limitations of EPS

It helps to remember though that EPS can be impacted by a company’s change in policies. EPS may also give a clear picture of a company and its position when the firm opts for buyback of shares or when there are mergers and acquisitions. Also, different companies may have their own accounting methods or principles, and in some situations, EPS may not be comparable.

Conclusion

Earnings per share is an important measure that indicates a company’s financial health and profitability. It is computed by dividing a company’s net income by the total outstanding shares. Traders and analysts use the EPS formula to compare two firms in the same sector or industry and take a call on their relative merits.

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FAQs

What is EPS?

EPS stands for Earnings Per Share. It is a financial metric representing a company’s earnings for each outstanding share. EPS allows investors to estimate a company’s profitability and compare it with the industry average and peers.

How is EPS calculated?

EPS is the net profit of the company divided by the average number of outstanding shares. The Earnings Per Share formula is written below.

EPS= Net income – Preferred dividends / weighted average number of shares outstanding

This provides a per-share measure of the company’s profitability.

Why is EPS important?

EPS is critical for fundamental analysis. It helps investors assess a company’s financial performance and profitability. Investors use EPS to compare companies with their industry and competition.

Investors view a company’s profit and worth as higher if its EPS value is high.

What is the difference between basic and diluted EPS?

Basic EPS considers only the currently outstanding shares, while diluted EPS includes the impact of potential shares from convertible securities like convertible bonds and preferred shares. Diluted EPS provides a more conservative valuation for the company’s EPS.

What is considered a good EPS?

A “good” EPS depends on factors like the industry, company size, and market conditions. A higher EPS is perceived as favourable by investors, but EPS alone can’t give a complete picture, and its value can be manipulated. For correct valuation, EPS should be considered in conjunction with the company’s historical performance, industry benchmarks, and market expectations.