- Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock.
- EPS (for a company with preferred and common stock) = (net income - preferred dividends) ÷ average outstanding common shares
- EPS is sometimes known as the bottom line—the final statement, both literally and figuratively, of a firm's worth.
The Significance of Earnings Per Share (EPS)
EPS is one measure that can serve as a proxy of a company's financial health. If all of a company's profits were paid out to its shareholders, EPS is the portion of a company's net income that would be allocated to each outstanding share.
EPS is typically used by analysts and traders to gauge the financial strength of a company. It is often considered to be one of the most important variables in determining a stock's value. Many investors still look to EPS as a gauge of a company's profitability. In fact, it is sometimes known as the bottom line—the final statement, both literally and figuratively, of a firm's worth.
A higher EPS means 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. Investors may also pay attention to trends in EPS growth in order to get a better idea of how profitable a company has been in the past and to get a sense of its future prospects. 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. This measurement figures into the earnings portion of the price-earnings (P/E) 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.
Calculating Earnings Per Share
EPS is calculated as follows:
EPS = net income - preferred dividends / average outstanding common shares
As an example, suppose the fiscal year 2017 net income for Bank of America (BAC). Its net income was $18.232 billion. Its preferred stock dividends were $1.614 billion. Its average outstanding common shares stood at 10.196 billion. This puts its 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, Bank of America actually did this in 2017. In doing so, a company can improve its EPS (because there are fewer shares outstanding) without actually improving its 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 Bank of America 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.
However, not all companies have preferred stock. Some only offer 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.
A company's trailing EPS is based on the previous year’s number. It 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.
This measurement 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 is based on future numbers. This measurement includes projections for some period of time in the future (usually 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 on actual data, investors are often very interested in forward EPS because, in general, investing is predicated on estimates of a company's future earning potential.
Investors often compare these different EPS calculations. For example, they may compare the forward EPS (that makes future projections) with the company’s actual EPS for the current quarter. If the actual EPS falls short of forward EPS projections, the stock price may fall. On the other hand, if the actual EPS beats its estimates, the stock may experience a rally.
The Bottom Line
EPS becomes especially meaningful when investors look at both historical and 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 Bank of America with other stocks in the financial services field, such as JPMorgan Chase (JPM) or Wells Fargo (WFC). Since EPS is only one number, it’s essential to use it in conjunction with other performance measures before making any investment decisions.