When you are considering investing in a company’s stock, it is very important to understand its profitability. One essential metric when evaluating profitability is the earnings per share (EPS). It shows how much profit a company makes for each share of its stock. Generally, a company with a higher EPS is more profitable.
Imagine a pizza. The pizza is the company’s profit. You cut the pizza into slices (shares). EPS tells you how big each slice is. A bigger slice means a more profitable company. In this article, we will discuss what EPS is, how to calculate it, and how you can use it to check the financial health of a company.
The EPS Formula
To calculate EPS, you need two main pieces of information:
- Net income: This is the total profit a company has after paying all expenses, taxes, and interest.
- Average outstanding shares: This is the total number of shares of the company’s stock that are owned by investors.
The EPS formula is:
EPS = Net Income / Average Outstanding Shares
EPS Example
Let’s calculate the Earnings Per Share (EPS) for a company that has the following details:
Given:
- Net Income = $1,000,000
- Average Outstanding Shares = 500,000
Formula:
- EPS = Net Income / Average Outstanding Shares
Calculation:
- EPS = $1,000,000 / 500,000
- EPS = $2
Interpretation: This means the company earns $2 for each share of common stock outstanding.
How to Use an Earnings per Share Calculator?
An EPS calculator simplifies the process of calculating EPS manually. Here’s a step-by-step guide to using an EPS calculator:
Step 1: Gather Financial Information
Before you start using the earnings per share calculator, collect the necessary financial data. You need:
- Net income (from the company’s income statement)
- Dividends on preferred stock (if any)
- Number of outstanding shares (from the company’s balance sheet)
Step 2: Input the Data
Enter the gathered data into the EPS calculator offered by Calculatored.com. The tool has fields where you can input net income, preferred dividends, and outstanding shares to calculate earnings per share.
Step 3: Calculate EPS
Hit on the calculate button. The earnings per share calculator will automatically calculate the EPS based on the formula mentioned earlier.
Step 4: Analyze the Results
Once you have the EPS, you can compare it with other companies in the same industry. Higher EPS indicates better profitability. However, also consider other financial metrics for a comprehensive analysis.
Why EPS is Important?
EPS is a crucial metric for many reasons:
- Measures Profitability: EPS directly shows a company’s profitability on a per-share basis. This helps investors see how effectively a company is generating profit relative to its stock.
- Influences Stock Price: EPS can also influence a company’s stock price. Higher EPS often leads to a higher stock price because it indicates better profitability. Investors are ready to pay more for a company that’s doing well.
- Aids in Comparison: It helps you do a comparison between different companies. Investors can compare EPS values to determine which company is more profitable, even if the companies are of different sizes.
Limitations of EPS
No doubt EPS is a valuable metric, but it has some limitations:
Does Not Reflect Cash Flow
EPS is calculated using net income, not the actual cash flow. A company might have high EPS but low cash flow which indicates potential financial issues.
Affected by Accounting Practices
EPS can be affected by various accounting methods and practices. Companies might use different tricks to temporarily increase their EPS.
Ignores Share Dilution
EPS doesn’t consider the impact of things like stock options or convertible securities that could reduce the value of shares. Dilution can reduce the actual earnings available to each share.
EPS Variations
There are different variations of EPS that provide additional insights:
- Basic EPS: Basic EPS is calculated using the total number of outstanding shares. It provides a straightforward measure of profitability.
- Diluted EPS: Diluted EPS considers the potential dilution from convertible securities like stock options and warrants. It provides a more balanced view of EPS.
● Adjusted EPS: Adjusted EPS removes one-time gains or losses that aren’t expected to happen again. It gives a better idea of how much money a company really makes from its main business.