I. Introduction
Welcome to our guide on how to calculate earnings per share (EPS)! As an investor in the stock market, it’s important to understand how to calculate this key financial ratio in order to make informed investment decisions. In this article, we will provide you with a step-by-step guide on how to calculate EPS, as well as explore its importance, basic vs. diluted EPS, the impact of stock splits and dividends, and factors that affect EPS. We will also provide real-life examples and explain how investors use EPS in investment decision-making.
II. An Overview of Earnings Per Share (EPS)
Earnings per share (EPS) is a financial ratio that is calculated by dividing a company’s net income by its total number of outstanding shares. EPS is an important metric to investors as it provides a measure of a company’s profitability on a per-share basis. Essentially, EPS measures the amount of earnings that a company generates for each outstanding share of its stock.
Investors use EPS as a tool to evaluate a company’s financial health and performance. It is a critical factor in determining a company’s stock price, as investors are more likely to buy stock in companies that have strong EPS growth.
III. Step-by-Step Calculation of EPS
The basic formula for calculating EPS is:
EPS = (Net Income – Preferred Dividends) / Average Outstanding Shares
To calculate EPS, you will need to follow these steps:
- Find a company’s net income (also known as earnings or profit) on its most recent income statement. This can typically be found under the “Net Income” or “Earnings” section.
- Subtract any preferred dividends that the company may have paid out. Preferred dividends are payments made to preferred stockholders that have priority over common stockholders.
- Calculate the average number of outstanding shares. To do this, you will need to take the sum of the outstanding shares at the beginning and end of the period and divide by two.
- Once you have the net income and the average number of outstanding shares, you can use the formula to calculate EPS.
Let’s look at an example:
A company has a net income of $10 million, paid out $2 million in preferred dividends, and has 5 million shares outstanding at the beginning of the year and 6 million at the end of the year. To calculate EPS, we would first calculate the average number of outstanding shares:
Average Outstanding Shares = (5,000,000 + 6,000,000) / 2 = 5,500,000
Next, we can use the basic EPS formula:
EPS = ($10,000,000 – $2,000,000) / 5,500,000 = $1.45
This means that the company generated $1.45 in earnings for each outstanding share of its stock.
IV. Basic EPS vs. Diluted EPS
When calculating EPS, there are two types of EPS that can be calculated: basic EPS and diluted EPS.
Basic EPS is calculated using the total number of outstanding shares, without taking into account any potential dilution from stock options or convertible securities. Diluted EPS, on the other hand, takes into account the potential dilution that could occur if all stock options and other convertible securities were exercised, resulting in more shares of stock in circulation.
Generally, if a company has stock options or convertible securities outstanding, its diluted EPS will be lower than its basic EPS.
Let’s look at an example:
A company has a net income of $10 million, paid out $2 million in preferred dividends, has 5 million shares outstanding at the beginning of the year, and 6 million shares at the end of the year. The company also has 500,000 stock options outstanding that could potentially be exercised at a price of $20 per share.
To calculate basic EPS, we would use the formula we previously discussed:
Basic EPS = ($10,000,000 – $2,000,000) / 5,500,000 = $1.45
To calculate diluted EPS, we would need to factor in the potential dilution from the stock options:
Diluted EPS = ($10,000,000 – $2,000,000) / (5,500,000 + (500,000 x ($20 – $10))) = $1.36
As you can see, the diluted EPS is lower than the basic EPS, as it takes into account the potential dilution from the stock options.
V. Impact of Stock Splits and Stock Dividends on EPS
Stock splits and stock dividends can impact a company’s EPS. A stock split is when a company increases the number of shares outstanding by issuing additional shares to current shareholders. A stock dividend is similar, but instead of issuing additional shares, the company issues additional shares to current shareholders as a dividend.
From an EPS perspective, stock splits and dividends lower the per-share value of the stock, as there are now more shares outstanding. However, this does not necessarily mean that the value of the company has changed. For example, if a company had 10 million shares outstanding at a value of $10 each, its market capitalization would be $100 million. If the company then issues a 2-for-1 stock split, it would now have 20 million shares outstanding at a value of $5 each, resulting in the same market capitalization of $100 million.
Let’s take a look at an example:
A company has a net income of $10 million, paid out $2 million in preferred dividends, and has 5 million shares outstanding at the beginning of the year. The company then issues a 2-for-1 stock split, resulting in 10 million shares outstanding at the end of the year.
To calculate EPS, we would first calculate the average number of outstanding shares:
Average Outstanding Shares = (5,000,000 + 10,000,000) / 2 = 7,500,000
Next, we can use the basic EPS formula:
EPS = ($10,000,000 – $2,000,000) / 7,500,000 = $1.07
As you can see, the EPS has decreased from the previous example, even though the company’s net income and number of shares outstanding have remained the same. This is due to the impact of the stock split, which has increased the number of shares outstanding.
VI. Factors that Affect the EPS of a Company
There are several factors that can impact a company’s EPS, including the number of outstanding shares, its net income, and any dividends paid out to shareholders.
For example, if a company has a large amount of debt, this can impact its net income, which will in turn impact its EPS. Additionally, if a company issues more shares to raise capital, this will increase the number of outstanding shares and decrease the EPS.
It’s important to understand the different factors that can impact a company’s EPS, as this can help investors make informed investment decisions.
VII. Comparison of EPS between Companies and Industries
When evaluating a company’s EPS, it’s important to compare it to other companies in the same industry and sector. This helps to provide context and perspective on the company’s financial performance.
To compare EPS between companies, investors can use financial websites to access and compare financial data. Additionally, investors can calculate price-to-earnings (P/E) ratios for companies within the same industry, which compares a company’s stock price to its EPS. This can help to provide insight into how the market values companies within a particular industry.
Comparing EPS between companies and industries can be useful in identifying potential investment opportunities and making informed investment decisions.
VIII. Real-Life Examples of How EPS is Utilized by Investors
Investors utilize EPS in various ways to make investment decisions. For example, investors may look for companies with high EPS growth rates, as this can indicate strong financial performance and potential for future growth.
Additionally, investors may use EPS to compare companies within the same industry and sector, as we previously discussed. EPS can also be used in conjunction with other financial metrics, such as P/E ratios, to gain a more comprehensive understanding of a company’s financial health.
Here are a few real-life examples of how EPS has influenced investment decisions:
- Amazon’s EPS growth in recent years has been a major factor in its success on the stock market, as investors see the company’s earnings potential as high.
- In 2018, Apple’s stock price dropped after it reported lower-than-expected EPS for the quarter. This highlighted the importance of EPS to investors in evaluating a company’s financial health.
- Investors may choose to invest in a company with a higher EPS than its competitors, as this can indicate that the company is more profitable than others within the same industry.
IX. Conclusion
Calculating EPS is an important skill for investors to have in order to make informed investment decisions. We hope that this guide has provided you with a better understanding of what EPS is, how to calculate it, and the various factors that can impact it.
Remember, when evaluating a company’s EPS, it’s important to compare it to other companies in the same industry and sector, as well as consider other financial metrics. By utilizing EPS and other financial tools, investors can gain a better understanding of a company’s financial health and make informed investment decisions.