## What is 'Earnings Per Share - EPS'

Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability. EPS is calculated as:

EPS = (Net Income - Dividends on Preferred Stock) / Average Outstanding Shares

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## How to Calculate 'Earnings Per Share - EPS'

To calculate the EPS of a company, the balance sheet and income statement should be used to find the total number of shares outstanding, dividends on preferred stock (if any), and the net income or profit value. When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. Any stock dividends or splits that occur must be reflected in the calculation of the weighted average number of shares outstanding. However, data sources sometimes simplify the calculation by using the number of shares outstanding at the end of a period.

Let's calculate the EPS for a couple of companies for fiscal year ended 2016:

 Company Earnings (Net Income) Preferred Dividends Weighted Shares Outstanding Basic EPS Ford Motors Company \$1.23 billion 0 3.97 billion \$1.23/3.97 = \$0.31 Wal-Mart Inc. \$13.64 billion 0 3.1 billion \$13.64/3.1 = \$4.40 NVIDIA Corporation \$1.67 billion 0 541 million \$1.67/0.541 = \$3.08 McDonald's Corporation \$4.69 billion 0 854 million \$4.69/0.854 = \$5.49

## Basic vs. Diluted EPS

The formula used in the table above calculates the basic EPS of each of these select companies. Basic EPS does not factor in the dilutive effect of additional securities. When the capital structure of a company includes stock options, warrants, restricted stock units (RSU), etc. these investments, if exercised, could increase the total number of shares outstanding in the market. To better show the effects of additional securities on per share earnings, companies also report the diluted EPS, which expands on basic EPS by including convertible securities in the outstanding shares number. The diluted EPS is the worst-case scenario for the earnings per share if certain securities were converted to common stock.

For example, the total number of NVIDIA's convertible instruments for the fiscal year ended 2016 is 108 million. If this number is added to its total shares outstanding, its diluted weighted average shares outstanding will be 541 million + 108 million = 649 million shares. The company's diluted EPS is, therefore, \$1.67 billion / 649 million = \$2.57.

## Importance of Earnings Per Share - EPS

Earnings per share (EPS) is generally considered to be the single most important variable in determining a share's price. It is also a major component used to calculate the price-to-earnings (P/E) valuation ratio, where the 'E' in P/E refers to EPS. By dividing a company's share price by its earnings per share, an investor can understand the fair market value of a stock in terms of what the market is willing to pay based on a company's current earnings.

The EPS is an important fundamental used in valuing a company because it breaks down a firm's profits on a per share basis. This is especially important as the number of shares outstanding could change, and the total earnings of a company might not be a real measure of profitability for investors. If Ford's total earnings were to increase in a subsequent year to \$1.8 billion, this might seem like great news to an investor until they consider the fact that the company's total shares outstanding increased to 4.5 billion. In this case, EPS would have only gone up to \$0.40.

## In the Markets

An important aspect of EPS that's often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS number, but one could do so with less equity (investment) - that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company. Investors also need to be aware of earnings manipulation that will affect the quality of the earnings number. It is important not to rely on any one financial measure, but to use it in conjunction with statement analysis and other measures.

For more on EPS, read The 5 Different Types Of Earnings Per Share (EPS) and How To Evaluate The Quality Of EPS

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