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What Is Earnings Per Share

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 financial health. In other words, earnings per share is the portion of a company's net income that would be earned per share if all the profits were paid out to its shareholders. EPS is used typically by analysts and traders to establish the financial strength of a company.

How Earnings Per Share Is Interpreted By Investors

  • A higher EPS means that a company is profitable enough to payout more money to its shareholders. For example, a company might increase its dividend as earnings increase over time.  
  • Investors typically compare the EPS of two companies within the same industry to get a sense of how the company is performing relative to its peers. 
  • Establishing trends in EPS growth gives a better idea of how profitable a company has been in the past and may be in the future. A company with a steadily increasing EPS is considered to be a more reliable investment than one whose EPS is on the decline or varies substantially.
  • EPS is also an important variable in determining a stock’s value since it provides the “E” or earnings portion of the P/E (price-earnings) valuation ratio. The price-to-earnings ratio is one of the most common ratios utilized by investors in determining whether a company's stock price is valued properly relative to its earnings. 
  • It's important to note that some companies reinvest their profits to grow the business, for example, technology companies. However, investors still look to EPS as a gauge of a company's profitability.

How To Calculate Earnings Per Share

EPS is calculated as follows:

EPS = net income ÷ average outstanding common shares

For example, Bank of America Corporation (BAC), reported fiscal year 2017 net income of $16.61 billion and had 10.19 billion average shares outstanding. Investors can calculate the EPS as:
 
EPS = $16.61 billion (net income) ÷ 10.19 billion (avg. outstanding shares) = $1.63

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. In other words, the net income gets divided up by a fewer number of shares, thus increasing the EPS. 

For example, if BAC had used a share buy-back program and bought 1 billion shares, its EPS would have been:

EPS = $16.61 billion (net income) ÷ 9.19 billion (avg. outstanding shares) = $1.80

You'll notice in our example above we used the average outstanding shares in our formula. Typically an average is used since companies may issue or buyback stock throughout the year making the true EPS difficult to pin down. Since the number of shares can frequently change, using an average of outstanding shares, gives us a more accurate picture of the earnings for the company. 

Please 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

Takeaways

  • In our example, Bank of America had an EPS of $1.63 for the fiscal year of 2017. 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.
  • Bank of America, for example, is in the financial services industry. As a result, investors should compare the EPS of BAC with other stocks in the financial services sector such as JPMorgan Chase & Co. (JPM) or Wells Fargo Co. (WFC).
  • Since EPS is only one number, it’s essential to use it in conjunction with other performance measures before making any investment decisions. 
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