Earnings per share formula

EPS applied to common shareholders

Earnings per share example

Basic vs. diluted EPS

Other ways to calculate earnings per share

Why is EPS important?

The bottom line

LearnStock AnalysisWhat Is Earnings Per Share (EPS)?

# What Is Earnings Per Share (EPS)?

Jun 21, 2022

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Earnings per share (EPS) is simply the company’s total dollar earnings for a given period, divided by the number of shares outstanding.

Earnings per share, or EPS, measures the performance of a publicly listed company. EPS is simply the company’s total dollar earnings for a given period, divided by the number of shares outstanding. Earnings are synonymous with profit and net income. The terms can be used interchangeably, though net income is the formal accounting term typically used in company financial reports.

## Earnings per share formula

The EPS formula is simple:

Net income for period (i.e., quarter) / Number of shares outstanding

Earnings per share answers the question: What’s in it for me if Company X reported \$XXX million in earnings and I own one share? It makes earnings personal.

So, for example, if Company X reported \$100 million in net income for the quarter and it has 50 million shares outstanding, earnings per share (EPS) are:

\$100,000,000 / 50,000,000 = \$2 per share

## EPS applied to common shareholders

Two kinds of shares are sold by companies:

• Common shares.

Sometimes called ordinary shares, these only have a claim on earnings after the company has paid all obligations. Owners are the only ones who can vote at the company’s annual shareholders’ meeting.

• Preferred shares.

These don’t offer voting rights but a prior claim on earnings through payment of dividends. The preferred dividends are an obligation—the company must subtract them from net income before calculating what is attributable to common shareholders.

The formula for earnings per share for preferred shares is thus modified:

Net income for period - preferred stock dividends / Number of shares outstanding.

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## Earnings per share example

Let’s use a real example of how EPS looks when preferred dividends are involved.

JPMorgan Chase & Co. reported net income of \$14.30 billion for the first quarter of 2021. Net income attributed to common shareholders was \$13.85 billion—meaning the company made about \$450 million in preferred stock dividend payments before calculating EPS. Its calculation for basic EPS was:

\$13.85 billion / 3.074 billion weighted average shares outstanding = \$4.51 per share

Without the preferred dividend obligations, JPMorgan’s earnings per share would have been about \$4.65.

## Basic vs. diluted EPS

A distinction needs to be made between basic and diluted EPS. Diluted EPS, unlike the formula for basic EPS, accounts for all potential shares outstanding.

Companies that have granted options to executives to buy shares at future dates, or that have sold bonds with provisions allowing holders to convert their debt holdings to shares, must calculate diluted EPS. This assumes all stock options outstanding have been exercised and any convertible debt has been exchanged for shares. The result is to increase the theoretical number of shares outstanding and spread out, or dilute, how much net income flows to each share.

Most investors rely on diluted EPS because it’s more conservative, taking into account all contingencies that could affect a company’s per-share calculations. In JPMorgan’s case, it was a minor difference. Diluted EPS was \$4.50, only a penny less than basic EPS because the company had only about 5 million more shares outstanding when taking into account stock options and convertible debt.

Some companies will have more earnings dilution than others, depending on their use of stock options and convertible debt. In newer industries, such as biotechnology, companies are more likely to offer stock options as a substantial part of compensation in lieu of cash salary until the companies establish sales growth and become profitable.

In contrast to dilution, a company may decide to repurchase some of its shares from investors at current market prices, which would serve to boost earnings per share, as net income would be divided by fewer shares outstanding. Options, convertible debt, and stock repurchases, sometimes known as buybacks, can complicate the job of determining an appropriate number for calculating earnings per share. Companies typically use one of two methods:

• End of period shares outstanding.

The company uses the number of shares outstanding on the last day of the period to calculate EPS. So for example, InFlight Corp. (a hypothetical company) had 5 million shares outstanding at the beginning of the quarter, and during the quarter 500,000 shares were added when executives exercised options and convertible-debt holders swapped into shares. The company will use 5,500,000 shares outstanding to calculate EPS. If net income was \$10 million for the quarter, then EPS would be:

\$10,000,000 / 5,500,000 = \$1.82

• Weighted average shares outstanding.

Most companies prefer this because it reflects the change over time in shares outstanding. Using the InFlight example above, let’s say the added shares from options and convertible debt occurred halfway through the quarter. So for the first half of the quarter, 5 million shares were outstanding, and for the second half, 5.5 million. Weighting works like this:

5,000,000 x 0.5 = 2,500,000 for first half

5,500,000 x 0.5 = 2,750,000 for second half

Adding the figures gives a weighted average of 5,250,000 shares for the quarter.

Calculating for InFlight’s EPS, the weighted method shows:

\$10,000,000/5,250,000 = \$1.90

Investors should be aware that a company can manipulate the shares outstanding through stock buybacks, resulting in fewer shares outstanding and higher EPS.

Stock splits should have no material effect. For instance, if InFlight decided on a 2-for-1 stock split and the market price at the time was \$20 a share, each investor would then have two shares valued at \$10. The EPS calculation would then attribute earnings of 95 cents—half of \$1.90—to each share using the weighted average method shown above. Companies that do stock splits will recalculate per-share earnings from past periods to reflect the stock split, otherwise, EPS before and after the split would look radically different.

## Other ways to calculate earnings per share

For the numerator in EPS—earnings—a company may emphasize other amounts than net income, which require closer inspection. Among them:

## Earnings/profit from continuing operations

This happens when a company closes or sells a part of its business, and asks investors to set aside that part in comparing its earnings. A company would argue this gives investors a more appropriate, apples-to-apples comparison of earnings using only the operations that remain.

Generally accepted accounting principles (known as GAAP) require the company to include the sold or discontinued operations when reporting net income. In drawing attention to earnings from continuing operations, the company is saying to investors: Accounting principles aside, the discontinued operations are behind us. Let’s move on.

A company will promote a comparison of adjusted earnings if something happens to change net income and it’s not expected to happen again. Companies describe this as an extraordinary or non-recurring event. Gains or losses on sales of business units or assets are among such events.

Let’s say InFlight Corp. sold a business unit called Silly Sounds Inc. for \$30 million in the recent quarter and recorded a gain of \$5 million on the sale, equivalent to about 90 cents a share. That would make net income \$15 million, or \$2.80 a share, for the recent quarter, compared with \$9.5 million, or \$1.80 a share, in the quarter a year earlier. Most of the increase comes from the extraordinary gain.

So InFlight adjusts the earnings comparison for investors by excluding the gain. It promotes the meaningful comparison for earnings of \$10 million, or \$1.90 a share, for the latest quarter,  versus \$9.5 million, or \$1.80, in the quarter a year earlier.

Both of these examples—profit from continuing operations and profit excluding extraordinary gains or losses—represent what-if scenarios for investors, called a pro forma comparison. It deviates from GAAP accounting because it includes some assumptions and projections about the company’s business and financial condition—the adjustments to earnings.

## Why is EPS important?

So what does an earnings per share number mean? By itself, it's little. Only in comparison with other numbers does EPS signify much—whether it’s a good or bad EPS. Such numbers include:

• The company’s stock price.

This is important because investors want to gauge the amount of earnings per share against the market price of a share—the price-to-earnings ratio, or P/E. For example, if the market price of InFlight is \$20 and earnings are \$1.90, the P/E ratio is 20/1.90 = 10.5. This means an investor would be willing to pay a price that’s 10.5 times InFlight’s latest reported earnings. A high P/E ratio suggests that investors are willing to pay more for each dollar a company earns.

• The company’s previous EPS.

Are earnings higher or lower than in the comparable year-earlier quarter? A historical trend or pattern in earnings helps investors decide whether to buy or sell the company’s shares.

• An average or consensus of estimates.

This may include the company’s earnings and estimates among professional investors and securities analysts. Was the reported EPS above or below their estimates? This comparison typically has some effect on the market price of the shares.

• Earnings of competitors in the same industry.

These are known as a company’s peer group. Comparing this way helps investors decide which company is the best bet. Other ratios, such as return on equity, which measures how profitably a company uses shareholders’ invested money (their equity capital), provide useful comparisons.

## The bottom line

Earnings per share is one of the most important measures of a company’s business performance, but investors need to pay close attention to how it arrives at its numbers. Many companies offer at least one variation of simple net income, with management comments and footnotes, for investors to evaluate.

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