Earnings per share or EPS is calculated as a company’s earnings – which do not account for the distribution of dividends — divided by the outstanding shares. Investors track this metric to get a sense of the progress of a company and determine the valuation.
When it comes to Wall Street analysts, they will forecast a company’s EPS. These will then be averaged into a consensus estimate. If a company exceeds this, the stock will likely increase on the news. And yes, if they fall short, the stock could fall.
Consider that you do not need earnings per share calculator. The good news is that the metric is widely available. The EPS is disclosed in a company’s quarterly financial statements. TipRanks also provides this for each stock on the Stock Analysis page.
The Earnings Per Share Formula
Here is how to calculate earnings per share (also known as the basic EPS formula):
Earnings per share = (earnings – preferred dividends) / weighted average common shares
The preferred stock dividends are excluded because they are not paid to the holders of the common shares. As for the weighted average, this is used since the number of shares can change during the quarter due to option exercises, findings, and buybacks.
It’s common to use the net income for the earnings. The reason is that this is based on GAAP (Generally Accepted Accounting Principles), which allows less leeway for companies to adjust the numbers.
However, some investors will use income from continuing operations for the earnings. This could be more representative since it will focus on the core business and exclude segments that have been discontinued.
Next, there are diluted EPS. The formula is similar to the basic EPS except that the denominator includes converted securities:
Diluted EPS = (Earnings – Preferred Dividends) / (Weighted Average Shares Outstanding + Converted Securities)
The use of converted securities assumes that all the options, warrants, preferred stocks, and convertibles will be turned into common stock. This is important since it will lower the EPS. This metric is also included in a company’s income statement for each quarterly report.
So which EPS calculation to use? It depends on the circumstances. If the stock price has increased significantly, it may be better to use diluted EPS since there is a higher likelihood that the securities will be converted. Moreover, there are certain companies – like tech firms – that issue large amounts of low-price options to employees. Thus, it may be more accurate to use diluted EPS.
Earnings Per Share Examples
|Weighted Common Shares
|$1.70 ($28.755 / 16.935)
|$14.39 (7.222 / 0.502)
|$2.05 (15.463 / 7.555)
|$4.42 (11.950 / 2.704)
|$0.74 (690 / 933)
Why Earnings Per Share Is Important?
For the most part, Wall Street values a company based on earnings. If they are increasing, then the stock price will usually increase and vice versa. Consider that many of history’s top-performing stocks, like Microsoft and Walmart, had long periods of strong EPS growth.
This should be no surprise. The increasing EPS is a sign that the company’s products are highly competitive and that the market is large. The earnings also allow a company to invest more in its operations, attract top-notch employees and pay dividends.
But EPS has some potential issues. One is that a company may aggressively buy back stocks to increase them. But this may mask underlying problems with the company’s operations. The buybacks may also be costly, such as requiring more debt.
Now if a company’s EPS declines, is this a bad sign? Perhaps so. This is likely the case if the declines happen over a prolonged period of time.
In some cases, the EPS may be negative, which is when a company is losing money. In general, this is a red flag.
Yet there are exceptions. During the early years of Amazon, the company posted ongoing negative EPS numbers. But of course, the shares would rise anyway as the company was building dominant positions in growth markets like eCommerce and cloud computing. Ultimately, the company would generate large profits.
But this was a risky strategy. Many other dot-coms were unable to make it work and have since gone bust or have merged with other companies.
Negative EPS could be due to a downturn in the economy. However, this is to be expected and will likely be temporary. This is why Wall Street analysts may normalize their EPS estimates to factor out the impact of the recession.
Something else to consider about EPS: Some management teams will be aggressive with their accounting policies. After all, a large part of their compensation will be based on the performance of the stock. But this could mean that the EPS is not a good measure of the performance of the company. In rare cases, there may even be fraudulent practices, as seen with Enron or WorldCom.
Earnings Per Share Versus The P/E Ratio
With EPS, you can come up with earnings per share ratio or a P/E ratio. This is a quick way to get a sense of the valuation of a stock and is calculated as follows:
Stock Price / EPS
It’s typical for a stock to have a ratio between 15X to 25X or so. If a company is growing fast, then the P/E ratio can be fairly high – say over 50 or even 100. On the other hand, if a company is declining and has few prospects for growth, the ratio can be low, say under 10.
EPS Versus DPS (Dividend Per Share)
The DPS (Dividend Per Share) is calculated as:
DPS = (Sum of Dividends for the quarter or year – Special Dividends) / Outstanding shares for the period
Suppose a company paid $100 million in dividends for the year and there was a special dividend of $50 million (this is excluded because it is a one-time item). The DPS would be:
($100 million – $50 million) / 80 million shares = 62.5 cents per share.
While the EPS provides a way to gauge the progress in profitability, the DPS shows whether the dividends are growing or not.
The EPS is clearly an important part of stock analysis. This allows for an easy way to get a sense of the progress of a company’s earnings.
But like any metric, it is not foolproof either. Companies can manipulate EPS with buybacks and aggressive accounting policies. This is why it is important to understand how it is calculated.
The EPS is also part of the calculation for the P/E ratio, which allows for a way to get a sense of the valuation of a stock. It is one of the most widely used metrics on Wall Street.