Earnings per share is a number that describes the portion of a company’s profit that is allocated for each stock.
Earnings per share are one of the most commonly used metrics for describing the company’s profitability.
Earnings per share are also the single important number that can affect the share prices. It is also very closely followed by both the investors and analysts, which can use in future earnings per share estimated for predicting movements in the stock prices.
When this number increases year by year, it can be usually followed by an increase in the stock price.
In easier words, it is the amount of profit owned by each company’s stock. If all the company’s profits are distributed to shareholders, then this is how much you will get for each stock you will own.
Earnings per share are one of the most important variables for determining a company’s share prices.
High earnings per share can indicate that the company is more profitable and has more profits for distribution.
Calculation of a company’s basic earnings per share is simple. If a company has 1,000 shares and on behalf of that, if the company is earning $10,000, its earnings per share are $10 per share.
If a company is paying dividends, then before calculation, they can be subtracted from the net income or profit.
There’s another way of calculating EPS called diluted earnings per share, which includes the value of convertible bonds and stock options if converted to stock in the number of outstanding shares.
Calculations of diluted EPS factor in the effects of any action that causes more stock to be issued, but what actions are factored in varies depending on the accounting standard used.
Earnings per share are also the major component in the price-to-earnings ratio calculation for valuing a company, which measures its value as a factor of its current share price relative to its EPS earnings per share.
For calculating the earnings per share there are several ways. So let’s learn about them.
Below mentioned formulas are both from the earnings per share:
EARNINGS PER SHARE = NET INCOME – PREFERRED DIVIDENDS / WEIGHTED AVERAGE NO OF SHARES OUTSTANDING
In earnings per share can use the first formula for total outstanding shares for calculating earnings per share. Still, the analysts may use the weighted average shares outstanding method while calculating the denominator if it is taken in practice.
Since outstanding shares can be changed over time, then analysts may often use last period shares outstanding. There is also often talk of diluted earnings per share in financial reports.
Diluted earnings per share include options, convertible securities, and even outstanding warrants and can also affect total shares outstanding when exercised.
Another type of earnings per share formula is adjusted EPS earnings per share. It can remove all non-core profits and losses, as well as those that are in minority interests. This calculation aims to see only profit or loss generated from core operations on a normalized basis.
Basic earnings per share are not a factor in the dilutive effect of shares issued by the company.
When a company’s capital structure includes some items such as stock options, warrants, or even restricted stock units, then these investments, if exercised then it could increase the total number of shares that are outstanding in the market.
For better illustration effects of additional securities on per-share earnings, the companies may also report the diluted earnings per share, which also assumes that all shares that can be outstanding have been issued.
E.g., if the total number of shares that can be created and can also be issued by NVIDIA’s convertible instruments for the particular, fiscal year ended in 2017 was 33 million.
If this number has been added to its total shares outstanding, its diluted weighted average shares can be like 599 million + 33 million = 632 million shares.
The company’s diluted earnings per share are, so it will be $3.05 billion divided by 632 million we get $4.82.
Sometimes there is a requirement of the numerator, which is adjusted while calculating fully diluted EPS earnings per share.
E.g., sometimes, a lender will also provide a loan to convert the debt into shares under certain conditions. It would include the convertible debt in the denominator of the diluted EPS calculation. Still, if this happens, then the company would not have paid interest on the debt.
So, the company or analyst will be adding the interest paid on convertible debt back into the numerator of the calculation of earnings per share calculation so that the result is not distorted.
There can be distortion because of earnings per share, both intentionally and unintentionally, by various factors.
Analysts can use variations of the basic earnings per share formula for avoiding the most common ways to inflate earnings per share.
Imagine a company that is owning two factories that manufactures cellphone screens. The land on which one of the factories is constructed has become very valuable because of new developments surrounding it over the past few years.
The company’s management team decides to sell the factory and build another less valuable land. This transaction will create a windfall profit for the company.
Though, suppose this land sale is creating real profits for the company and its shareholders.
In that case, it is considered an “extraordinary item” because there is no practical reason to believe that the company might repeat that transaction in the future.
It might also mislead the shareholders if the windfall is included in the numerator of the earnings per share equation, so it is excluded.
It could make a similar argument if a company had an unusual loss—maybe the factory burned down—which would have temporarily decreased earnings per share and should be excluded for the same reason.
A company started its year with 500 stores and has earnings per share of $5.00.
However, it can assume that this company have closed 100 stores over that period and can end the year with only 400 stores.
An analyst would want to know the earnings per share for just the 400 stores the company have planned to continue with into the upcoming next period.
This example could also increase the earnings per share because the 100 closed stores were perhaps operating at a loss.
An analyst can better compare prior performance to current performance by evaluating EPS earnings per share from continuing operations.
Below is the formula for calculating the earnings per share from continuing operations:
An important aspect of earnings per share is too often ignoring the capital required for generating the earnings, which means the net income in the calculation.
Two companies can also generate the same earnings per share, but one could do so with less number net assets; that company will be more efficiently using its capital for generating income and, all other things that have being equal, would be a “better” company in terms of efficiency.
A metric that is used for identifying more efficient companies is the return on equity.
Although earnings per share are widely used to track a company’s performance, the shareholders do not have any direct access to those profits.
A portion of this earnings can be distributed as a dividend, but the company can retain all or a portion of the EPS.
Through their representatives of the board of directors, shareholders will have to change the portion of earnings per share that will be distributed through dividends to access more of those profits.
Because shareholders cannot access the earnings per share, which is attributed to their shares, the connection between earnings per share and a share’s price can be difficult to define.
It is particularly true for those companies that don’t pay any dividends.
E.g., it is common for various technology companies to disclose in their initial public offering documents. The company do not have to pay a dividend and has no plans to do so in the future.
It is also difficult to explain that why these shares would have any value to the shareholders.
The actual notional value of earnings per share also has a relatively indirect relationship with their share price.
E.g., the earnings per share for two stocks could be identical, but it can be widely different in the share price.
E.g., in October 2018, Southwestern Energy Company has earned $1.06 per share in diluted earnings by continuing operations, with a share price of $5.56.
However, Mellanox Technologies has earnings per share of $1.02 by continuing operations with a share price of $70.58.
On the surface, it also seems like Southwestern Energy Company is the better deal because the investor is paying only $5.25 per dollar of earnings ($5.56 share price / $1.06 EPS = $5.25).
Investors in Mellanox Technologies are paying $69.20/dollar of earnings ($70.58 share price / $1.02 EPS = $69.20). This ratio can also be known as the earnings multiple or price-earnings ratio.
Although there is a comparison between MLNX and SWN is extreme, investors will generally compare earnings per share, and share prices between industry groups can be difficult for comparison.
Stocks that have been expected to grow (e.g., technology, retail, industrial) will have a larger price-to-EPS (P/E) ratio than those that are not expected to grow (e.g., utilities, consumer staples).
Comparing the price-earnings ratio within any industry group can be helpful, but it can be in unexpected ways.
Although it seems like the stock that costs more relative to its earnings per share while comparing to its peers, it might be “overvalued,” the opposite can be the rule.
Regardless of its earnings per share history, investors are willing for paying more for a stock if it is expected to grow or out-perform its peers.
It can be normal for the stocks with the highest price-earnings ratios in a stock index to out-perform the average of the other stocks in the index in a bull market.
Companies are getting increased earnings per share while their earnings increase or when their total number of outstanding shares decreases.
Earnings can also go up due to sales growing faster than expenses, or it is becoming more profitable by cutting down the costs.
Shares outstanding can be decreased due to share buybacks or increased when the company is issuing new shares.
Earnings per share are most commonly used, but it has its certain limitations.
E.g., unprofitable companies might have negative earnings per share, which makes the metric less useful. However, you can also use this trend for the number to see if the company is on the way to becoming profitable.
This number can also be misleading and manipulated by various accounting tricks.
E.g., many companies that are spending more cash than they are earning can be made to seem profitable with a positive number of earnings per share.
Because of this reason, it is considered a good idea to also looking at operating income and free cash flow, which are also other profitable metrics.
Earnings per share are used for calculating the price-earnings ratio, which is the most commonly used valuation metric for stocks.
Companies also often report that adjusted earnings per share where they remove certain expenses from the calculation. It can also sometimes mislead the investors.
A weighted average method of outstanding shares is often used for calculating the shares outstanding because this number can tend for fluctuation.
When a company is paying preferred dividends, this number can be subtracted from the total earnings figure before calculating earnings per share.
Earnings per share can also be reported for each quarter, for every fiscal year, or projected into the future with forwarding earnings per share.
It can be commonly used as a version of the trailing twelve months earnings per share, which can be calculated by adding up the numbers for the past four quarters.
The dividends on cumulative and non-cumulative are preferred stock impact the computation of earnings per share differently.
The dividend on cumulative preferred stock for the current period is always deducted from net income while computing the current period’s earnings per share even if management does not declare any division.
However, in non-cumulative preferred stock, the dividend is not deducted from the current period’s net income unless it is declared by management.
The dividends in arrears on cumulative are preferred for the previous periods are not deducted from the current period’s net income while computing earnings per share of the current period.
It can be deducted from the net income of previous periods for computing the earnings per share of those periods.
The shares are normally purchased to earn dividends or sell them at a higher price in the future.
Earnings per share figures are extremely important for actual and potential common stockholders because the payment of dividends and increase in the value of stock in the future largely depend on the company’s earning power.
Earnings per share are the most widely quoted and relied upon figure by analysts, stockholders, and potential investors. In several countries, many public companies are legally required for reporting this figure in the income statement. It can be usually reported below the net income figure.
There is no particular rule to interpret earnings per share of a company. The higher the earnings per share figure, the better it is and improves your time interest earned ratio.
Higher earnings per share are the sign of higher earnings, a strong financial position, and a reliable company for the investors for investing their money.
The earnings per share figure for only a single accounting period do not always reveal that cannot consider the real earning potential of the business enough for making an investment decision.
For meaningful analysis, the analyst or investor should calculate the Earnings per share figure for several years and also compare it with the earnings per share figure of other similar companies in the industry.
A consistent improvement in the earnings per share figure year after year is the indication of continuous improvement in the company’s earning power.
Analysts, investors and potential stockholders are preferred to use the earnings per share ratio in conjunction with other relevant ratios.
For example, the EPS figure is often compared with the company’s per-share price by computing the price-earnings ratio, usually abbreviated as a price-earnings ratio.
In comparison, the price-earnings ratio compares the different companies revealing the reasonability in the market price of a company’s stock.
It also indicates that whether a particular company’s stock is at a certain market price can be cheap or expensive, concerning similar companies’ stocks that are trading in the market.
Other matrices that can commonly consider and the earnings per share ratio for judging the justification of stock price are included in the dividend to yield the ratio and annual dividend per share.
The shares are normally purchased to earn dividends or even sell them at a higher price in future.
Earnings per share figures are extremely important for actual and potential common stockholders because the payment of dividends and increase in the value of stock in the future largely depends on the company’s earning power.
Earnings per share are the most widely quoted and relied on a figure by analysts, stockholders and potential investors.
In many countries, public companies are usually legally required to report this figure in their income statement. It is usually reported that below the net income is figured.
There is no particular rule for interpreting the earnings per share of a company.
The higher the earnings per share figure is, the better it is. Higher earnings per share are the sign of higher earnings, a strong financial position, and hence it is a reliable company for investors for investing their money.
Earnings per share figures for only a single accounting period that does not reveal the actual earning potential of the business, and it should not be considered enough for making an investment decision.
For meaningful analysis, the analyst or investor should calculate the EPS earnings per share figure for several years and compare it with the earnings per share, figuring out other similar companies in the industry.
A consistent improvement in the earnings per share figure year after year indicates continuous improvement in the company’s earning power.
Analysts, investors, and potential stockholders prefer to use the earnings per share ratio in conjunction with other relevant ratios.
For example, the EPS figure is often compared with the company’s per-share price by computing the price-earnings ratio (usually abbreviated as P/E ratio).
The P/E ratio comparison of different companies reveals the reasonability of the market price of a company’s stock.
It indicates whether a particular company’s stock at a certain market price is cheap or expensive concerning similar companies’ stocks trading in the market.
Other matrices that are mostly considered along with earnings per share ratio to judge the justification of stock price include dividend yield ratio and annual dividend per share.
Fequently Asked Questions-
What counts as good earnings per share will depend on some factors, such as the recent performance of the company or the performance of its competitors and even the analysts’ expectations who can follow the stock. Sometimes, a company might also report growth in earnings per share, but the stock might be in a declining position in price if analysts were expected to have an even higher number.
Likewise, a shrinking EPS figure might nonetheless lead to a price increase if analysts were expecting an even worse result. It is important to always judge EPS with the company’s share price by looking at its P/E or earnings yield.
Sometimes the analyst might have to distinguish between “basic” and “diluted” earnings per share.
Basic earnings per share consist of the company’s net income divided by its outstanding shares. The figure is most commonly reported in the financial media, and it is also the simplest definition of EPS earnings per share.
On the other hand, Diluted earnings per share will always have to be equal to or lower than basic earnings per share because it includes a more expansive definition of its outstanding shares.
Specifically, it incorporates shares that are not currently outstanding but could become outstanding if stock options and other convertible securities were to be exercised.
After collecting all necessary data, input the net income, all preferred dividends, and the number of common shares outstanding into three adjacent cells, say B3 through B5. In cell B6, input the formula “=B3-B4” to subtract preferred dividends from net income.
In cell B7, input the formula “=B6/B5” to render the EPS ratio.
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