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Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, serving as an indicator of the company’s profitability. It is often considered to be one of the most important variables in determining a stock’s value, and it comprises the “E” part of the P/E (price-earnings) valuation ratio. EPS is calculated as:

EPS = net income / average outstanding common shares

For example, McGraw Hill Financial Inc (MHFI) reported first quarter 2014 net income of $248 million and had 277.2 million average shares outstanding. To calculate EPS, investors can insert these figures into the EPS calculation:

EPS = $248 million / 277.2 million = $0.89

Companies may choose to buy back their own shares in the open market. In doing so, a company can improve its EPS (because there are fewer shares outstanding) without actually improving net income. For example, if MHFI in the first quarter had used a share buy-back program to buy 100 million shares, its EPS would have been:

EPS = $248 million / 177.2 million = $1.40

Note: some companies have a special class of stock called preferred stock. Any dividends paid on preferred stock would be subtracted from net income when calculating EPS. The formula for calculating EPS would then be:

EPS = (net income – dividends on preferred stock) / average outstanding common shares

In our example, MHFI had and EPS of 89 cents for the first quarter of 2014. Knowing the EPS of an individual stock is not enough information to make an informed investment decision. EPS becomes meaningful when investors look at historical EPS figures for the same company, or when they compare EPS for companies within the same industry. MHFI, for example, is in the Business Services industry, so investors could consider the EPS of other stocks within that industry, such as Moody’s Corp (MCO). Since EPS is only one number, it’s important to use it in conjunction with other measures before making any investment decisions.

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