Earnings Per Share (EPS) is a financial ratio investors use to evaluate a company’s profitability. It represents the portion of a company’s net earnings allocated to each outstanding share of common stock. By examining EPS, you gain valuable insights into a company’s ability to generate and distribute profits to its shareholders.
This article will cover in more detail what EPS is, how to calculate it, and how it affects stock valuation.
What is Earnings Per Share?
Earnings per share, or EPS, is a measure of a company’s profitability, computed by dividing net income by the total number of outstanding common shares. The resulting number shows whether a company is profitable or not.
The higher the EPS, the more profitable a company is on a per-share basis. A higher EPS generally indicates that a company is generating more earnings for each outstanding share of its common stock.
Types of EPS
There are three common types of earnings per share:
Trailing EPS
Also known as TTM EPS (Trailing Twelve Months EPS), trailing EPS reflects a company’s earnings per share over the most recent twelve-month period. It provides a historical view of the company’s profitability and financial performance over the past year.
Trailing EPS considers the company’s cumulative net earnings for the four most recent quarters. This metric is useful for assessing a company’s recent track record and evaluating its historical earnings trend.
Since trailing EPS provides historical data, most investors will also look at forward EPS.
Forward EPS
The forward EPS represents Wall Street analysts’ consensus estimates of a company’s future earnings per share for a specified period. This could be the next quarter, fiscal year, or multiple years ahead. The most commonly used period is Next Twelve Months (NTM) EPS, which is the summation of the next four quarters of forecasted EPS.
Forward EPS is based on forecasts and expectations about the company’s future financial performance. Investors and analysts often use it to make projections about a company’s potential growth and estimate its valuation.
Basic EPS vs. Diluted EPS
The main difference between basic EPS and diluted EPS is that the former doesn’t take into account the potential dilution of outstanding shares from convertible securities, such as stock options and convertible bonds.
Diluted EPS considers the potential dilution of outstanding shares from convertible securities. It assumes that all potential dilutive securities have been converted into common shares. Diluted EPS provides a more conservative measure of a company’s earnings per share by accounting for the maximum possible dilution.
EPS vs. Adjusted EPS
Adjusted EPS is a modified version of basic EPS that excludes certain non-recurring or unusual items from the company’s net income to accurately reflect its ongoing operational performance. For example, Adjusted EPS may exclude one-time restructuring or legal costs.
These adjustments are typically made to eliminate items unrelated to the core business operations that would otherwise distort the true earnings picture.
Pro Tip: TIKR calculates Earnings Per Share in all forms (LTM, NTM, Adjusted, Basic, Diluted) on 100,000+ stocks globally.
How to Calculate Earnings Per Share
To calculate EPS, divide the net income (minus preferred dividends) by the average number of common outstanding shares.
Here’s the earnings per share formula:
- Net Income: This is the after-tax profits a company generates over a given period.
- Preferred Dividends: Since the EPS ratio represents earnings to common shareholders, we must deduct preferred dividends issued to preferred shareholders.
- Weighted Average Common Shares Outstanding: Investors and analysts typically use the weighted average to calculate EPS because the number of common shares outstanding may change over time.
Earnings Per Share Example
Let’s go through an example of EPS calculation using Apple. For its 2023 fiscal year, the company reported a net income of $97.0 billion, and the company had 15.8 billion weighted average diluted shares outstanding.
Apple didn’t have preferred stock outstanding, so we don’t need to subtract preferred dividends.
When you divide net income by the weighted average shares outstanding, you’ll get an EPS of $6.13:
What Is a Good Earnings Per Share?
There’s no exact number to define a good EPS across companies. Because so many factors go into a company’s net income, EPS ratios always differ from one company to another. Also, companies can change the number of shares outstanding through stock splits or other means.
To find out if a company’s EPS is “good,” it’s a good idea to take into account its earnings per share in context. The absolute value of a company’s EPS should accelerate upward annually.
In the short term, stock prices can be driven by whether the company’s EPS is better than was forecasted by Wall Street analysts. If companies beat the EPS estimate, this can drive the stock price higher, especially in the short term. Conversely, if companies miss analyst estimates, this can sometimes cause the stock price to decline in the short term.
Over the long term, a company’s stock price generally converges with the intrinsic value of the underlying business. Generally, EPS is a decent proxy for intrinsic value per share over time.
For example, AAPL’s EPS has increased meaningfully over time, which has also driven its stock price higher:
How Earnings Per Share Affects a Stock’s Valuation
EPS is one of the many financial metrics investors use to determine whether a stock is a buy. A stock with a strong EPS growth rate is often considered a good investment, while a company with a declining EPS is generally a negative.
While EPS is a great metric for choosing stocks to buy, you shouldn’t use it solely. Using it alongside other financial ratios will give you a clear picture of a company’s profitability.
One commonly used valuation metric that’s used in conjunction with EPS is the Price-to-Earnings (P/E) ratio.
Limitations of EPS
Although EPS is a great profitability measure, it’s not without drawbacks.
For one, EPS is calculated using net income which doesn’t necessarily reflect a company’s cash flow. Subtracting non-cash expenses like amortization and depreciation from net income can cause a company’s net income to differ significantly across reporting periods.
In addition, companies can game their EPS by changing their accounting policies. They can also manipulate their Adjusted EPS metrics based on what they decide is one-time or non-recurring.
The EPS ratio is most useful when used alongside other financial ratios like the price-to-earnings (P/E) ratio and the return-on-equity (ROE) ratio.
FAQ Section
Why is EPS important for investors?
Earnings per Share (EPS) is important for investors because it shows how much profit a company generates for each share of stock, helping investors assess profitability and compare companies.
What is adjusted Earnings per Share (EPS) and how is it different from regular EPS?
Adjusted Earnings per Share (EPS) removes one-time items or unusual expenses, providing a clearer view of a company’s ongoing profitability compared to regular EPS.
How often is Earnings per Share (EPS) reported by companies?
Companies typically report Earnings per Share (EPS) quarterly and annually, as part of their financial reporting.
Can a company have a negative Earnings per Share (EPS)?
Yes, a company can have a negative Earnings per Share (EPS) if it incurs losses, meaning its expenses exceed its revenues.
How does Earnings per Share (EPS) impact dividend payments?
Earnings per Share (EPS) can impact dividend payments because companies with higher EPS are more likely to have the earnings capacity to pay or increase dividends.
TIKR Takeaway
EPS is an important financial metric that investors use to evaluate a company’s profitability.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold positions in any of the stocks mentioned in this article. Thank you for reading, and happy investing!
