Earnings Per Share, most commonly abbreviated to EPS is how much money a shareholder will earn from a company on a per share basis. Understanding how to calculate the EPS of potential companies to invest in.
This guide will include an explanation of what EPS, the formulas you need to know the different types of EPS, and additional important information.
What exactly is EPS:
Earnings Per Share Guide: How to Calculate EPS & More! is pretty much what the title suggests; it’s the amount of money a trader will earn back from every share they own in a company. However, there are a lot of things to keep in mind, as a trader cannot just look at the net profits of a company and assume that must mean that the EPS will be good.
The amount of shares outstanding is simply the amount of shares that have been bought by other traders. If two companies make around the same net profits it can be easy to assume that they both will have the same EPS, but that’s not the case. The company with more shares outstanding will have a lower EPS as more shareholders need to be paid which means the amount of capital on a per share basis decreases.
Why EPS is important:
The ratio of EPS is a useful tool for traders as it can help them understand why the stock costs as much as it does.
EPS is also useful in establishing the price-to-earnings ratio, also known as the P/E ratio. The P/E ratio is the stock price compared to the EPS which helps investors understand what the company is worth. This ratio shows traders how much they have to pay for their current earnings, or the earnings they could make in the future. The P/E ratio is calculated by diving the share price from the EPS.
EPS is overwhelmingly how well the company is performing for each individual shareholder as it tells them how much they will be making back on their investment, however, it is also useful for working out how valuable a company is in the first place. As EPS segregates the net proftis into small per-share units it gives traders a simple understanding of how profitable the company could be for them.
EPS is also useful for identifying trends. If the EPS company profits and EPS has been growing this is a positive sign as it suggests to potential shareholders that they can make a profit from the company. It can also suggest that the company will be able to invest profits into expanding the company, which can result in even larger earnings for investors. By looking at the EPS and company’s history with their dividends, traders can invest having a strong idea of what they can expect from said company.
How to calculate EPS:
The two most popular methods for calculating EPS as as follows:
Net Income ÷ Total Number of Shares Outstanding = Earnings Per Share
Net Income ÷ Weighted Average of Shares Outstanding = Earnings Per Share
Most traders prefer the second formula as the weighted average of shares outstanding garners more accurate results.
In order to calculate the weighted average of shares outstanding, traders need to have a look at the company’s balance sheet.
Shares outstanding is the sum of all the shares owned by traders, investors, and company employees and partners who may also own shares of the company. The shareholders’ equity is usually on the bottom of the balance sheet. Preferred stock, common stock, and treasury stock are included in shares outstanding. However, treasury stock is not always included; if it isn’t add the preferred stock and the common stock to get the number of shares outstanding, if it is present it needs to be subtracted from the sum.
To calculate the weighted average, traders need to multiply the amount of shares outstanding by the time period those shares were active in. The weighted average is important as the amount of shares outstanding can be affected by stock splitting or the issuing of more shares. For example: if a company has 1,000 outstanding shares for the first half of the fiscal year, where 6 months will be represented as 0.5 and then 500 shares outstanding for the second half of the year, the weighted average is 750.
1000 x 0.5 = 500
500 x 0.5 = 250
500 + 250 = 750
Basic vs diluted EPS
When traders refer to EPS and the formulas above, more often than not they mean basic EPS. Diluted EPS on the other hand takes into account how the likes of stock options and warrants can dilute the EPS by increasing the number of outstanding shares. Calculating the basic and diluted EPS is an excellent precaution for traders to take, as it can give traders a more realistic figure.
For example: a company made $15 million during the financial year with a weighted average of 30 million shares. The net income ($30m) needs to be divided by the number of shares (15) which gives you $0.50.
Types of EPS: trailing, current, and forward
Basic and diluted EPS are not the only types of EPS. Traders also take trailing, current and forward EPS into account as they paint a picture of the company’s past, present, and future.
Trailing EPS is the EPS of the company from previous years. It’s like a trail left behind by the company. If the EPS has been rising steadily each year, this suggests a positive trend to investors they will want to cash in on.
Current EPS is the estimated EPS for the current financial year. This is worked out by looking at the data to date and comparing it to the projections for the rest of the year.
Forward EPS is the projected EPS for the future. Traders need to look at current and trailing EPS to make an educated guess on what the forward EPS will be, and if they company’s future looks like something they would like to invest in.
While there is no guarantee that the current and forward EPS will unfold the way that traders predicted they would, they give a strong idea of where the company is heading and what they can hope to make from it.