Key Takeaways
- Earnings per Share (EPS) is a financial ratio between net earnings of the company and the average number of shares outstanding.
- Earnings per Share indicate a company’s ability to produce profits for its shareholders
- A higher EPS indicates better profitably whereas a lower EPS indicates lower profitability
- Earnings per Share alone is very arbitrary and is preferably used in conjunction with P/E ratio for the valuation of the company.
What are Earnings per Share?
Earnings per share or EPS is a financial ratio available to shareholders of a company which indicates a company’s ability to produce profits for the said shareholders. In other words, EPS is an indication of the company’s profitability.
Generally speaking, the higher the company’s EPS, more profitable it is considered. EPS is also one of the many indicators used by traders to pick stocks for either buying or selling.
Different companies have different number of shares that are owned by the public, so to only compare companies’ earning figure does not make complete sense about how much money each company makes for their shares. EPS is thus used to help analysts and investors to make appropriate and valid comparisons.
How to Calculate Earnings per share (EPS)?
EPS is a financial ratio between Net Earnings of the company available to the shareholders and average outstanding shares over a specific time period.
We use the average of outstanding shares over time due to the volatile nature of the shares, meaning that they can change over time. So to ensure that we have consistency in our analysis, we use the average.
Earning Per Share (EPS)
The formula for calculating Earnings per share is as follows:
Earnings per share (EPS) = Net Income – Preferred Dividends / Average of Outstanding shares
In order to find the net income, preferred dividends and number of outstanding shares, analysts will have to go through the company’s financial statements which include the balance sheet and the income statement. These should be available on the company’s website as well as on renowned websites related to financial literature.
The following example will help illustrate how to calculate EPS of an XYZ company with a net income of Rs. 20 million for the year 2019. Their preferred stock dividends were Rs. 3 million and their average outstanding common shares stood at around 10 million:
EPS = (Net Income – Preferred Dividends) / Average of Outstanding shares
EPS = (20m-3m)/10m
EPS = 1.7
Understanding EPS
Between the two companies of the same industry or comparison to the industry average, a higher EPS is an indication of better profitability of the company. Similarly, a low EPS indicates lesser profitability of the company.
It is important to understand that a company’s EPS value on its own will not tell you a lot; It is arbitrary in nature. It would, however, be more valuable for the analysts if they use it in comparison to other companies of the industry or the industry average itself or with the company’s Price to earning ratio (P/E ratio).
