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, 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.
How To Calculate Earnings Per Share
EPS is calculated as follows:
EPS = net income / average outstanding common shares
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 repurchase program and bought 1 billion shares, its EPS would have been:
$16.61 billion (net income) ÷ 9.19 billion (avg. outstanding shares) = $1.80
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.
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
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
- Current EPS – based on this year’s numbers, which are still projections
- Forward EPS – based on future numbers, which are projections
A trailing EPS uses the previous four quarters of earnings in its calculation, and has the benefit of using actual numbers instead of projections. Most price to earnings 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.
The 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.
A forward EPS is based purely on 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 since they want to know about the future earning potential of a company.
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 short 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.