What are earnings per share (EPS)? Calculating EPS
Earnings Per Share (EPS) is the amount of money that a company allocates to each outstanding share of a common stock. In other words, how much the company pays its common stockholders.
Put simply; a company’s EPS is its profit, minus dividends, divided by the total number of outstanding common shares.
Let’s suppose, for example, that a company earned $4 million in one year, i.e., after paying out dividends. Let’s also assume that it had 4 million common shares of stock outstanding. Its EPS, therefore, would be $1 per share.
The word ‘earnings’ comes from the root word ‘earn.’ ‘To earn‘ means to receive money for work that you have done.
Earnings per share vs. earnings
Do not confuse EPS with the term ‘earnings‘ on its own, which means ‘profits.’
In the US, the Financial Accounting Standards Board (FASB) requires companies to disclose information on EPS for continuing operations, discontinued operations, extraordinary items. The FASB also requires companies to disclose their net income.
Nasdaq.com has the following definition of EPS:
“A company’s profit divided by its number of common outstanding shares. If a company earning $2 million in one year had 2 million common shares of stock outstanding, its EPS would be $1 per share.”
“In calculating EPS, the company often uses a weighted average of shares outstanding over the reporting term.”
EPS is one of the financial attributes we look at when evaluating a company. Its financial attributes tell us how financially healthy or unhealthy a company is.
Preferred stock rights have priority over common stock. Therefore, before calculating the EPS, dividends declared on preferred shares are subtracted.
EPS is the single most important variable in calculating the price of a share. We also use it to calculate the price-to-earnings valuation ratio.
Diluted EPS includes the shares of warrants or convertibles outstanding in the outstanding shares number.
Calculating earnings per share:
Earnings per share (basic formula):
(Profit – Preferred Dividends) ÷ (Weighted Average Common Shares)
Earnings per share (net income formula):
(Net Income – Preferred Dividends) ÷ (Average Common Shares)
Earnings per share (continuing operations formula):
(Income From Continuing Operations – Preferred Dividends) ÷ (Weighted Average Common Shares)
Example of calculating earnings per share:
Let’s assume that a corporation has a net income of $10 million. Let’s also assume that the company pays out $2 million in preferred dividends.
It has 5 million shares for half of the year and 6 million shares for the other half. Its EPS, therefore, would be $1.45 (8/5.5).