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 and serves as a proxy of the company’s financial health. In other words, EPS is the portion of a company's net income that would be allocated to each outstanding share if all the profits were paid out to its shareholders. EPS is used typically by analysts and traders to gauge the financial strength of a company, and is often considered to be one of the most important variables in determining a stock’s value. In fact, it is sometimes known as "the bottom line" – the final statement, both literally and figuratively, of a firm's worth.
The Significance of EPS
- A higher EPS means that a company is profitable enough to pay out 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 P/E 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 (especially in the technology sector) reinvest their profits to grow the business. However, investors still look to EPS as a gauge of a company's profitability.
Calculating Earnings Per Share
EPS is calculated as follows:
EPS = net income - preferred dividends / average outstanding common shares
Let's take Bank of America's (BAC) fiscal year 2017 net income. Their net income was $18.232 billion. Their preferred stock dividends were $1.614 billion. Their average outstanding common shares stood at 10.196 billion. This puts their EPS at:
Earnings = 18.232 billion - 1.614 billion = 16.618 billion (net profit)
EPS = 16.618 billion ÷ 10.196 billion = ~$1.63
Diluted EPS, which accounts for the impact of convertible preferred shares, options, warrants, and other dilutive securities, was at $1.56.
Companies may choose to buy back their own shares in the open market (in fact, BAC did so in 2017). 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.
To make the example easy, let's say that BAC bought 1 billion shares back in 2017 through its share repurchase program. Its EPS would have been:
EPS = $16.618 billion (net income-preferred dividends) ÷ 9.196 billion (avg. outstanding shares) = ~1.81
You'll notice our example above used the average outstanding shares in the formula. Typically, an average is used since companies may issue or buy back 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 a more accurate picture of the earnings for the company.
Not all companies have preferred stock, instead only offering common shares. The formula for calculating EPS would then simply be:
EPS = net income / average outstanding common shares
Earnings Per Share Explained
Types of EPS
There are actually three basic types of EPS numbers, based on where the data comes from:
- Trailing EPS (based on the previous year’s number) - uses the previous four quarters of earnings in its calculation, and has the benefit of using actual numbers instead of projections. Most P/E ratios are calculated using the trailing EPS because it represents what actually happened, and not what might happen. Although the figure is accurate, the trailing EPS is “old news” and many investors will also look at current and forward EPS figures. We used a trailing EPS in our Bank of America example.
- Current EPS - typically includes the four quarters of the current fiscal year, some of which may have already elapsed, and some of which are yet to come. As a result, some of the data will be based on actual figures and some will be based on projections.
- Forward EPS (based on future numbers) - projections for some period of time in the future, typically the coming four quarters. Forward EPS estimates can be made by analysts or by the company itself. While this number is based on estimates and not facts, investors are often interested in forward EPS as investing is predicated on estimates of a company's future earning potential.
Investors often compare the different EPS calculations. For example, they may compare the forward EPS (projections) with the company’s actual earnings per share for the current quarter. If the actual EPS falls short of forward EPS projections, the stock price may fall. If the actual EPS beats estimates, however, the stock may experience a rally.
The Bottom Line
EPS becomes especially meaningful when investors look at historical and/or future 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 sector. As a result, investors should compare the EPS of BAC with other stocks in the financial services field, 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.