What is EPS in Stock Market? ( The Beginner To Expert Guide ):
EPS stands for Earnings per Share.
As a fundamental investor or the analyst understanding EPS is very useful and helpful to make the decision whether to invest in the company or not.
From this article on “What is EPS in Stock Market?” I will give you the brief details about the EPS in stock market by explaining the definition, types, formulas and many other important aspects for the same.
First of all we will start with the definition.
What is EPS in Stock Market?
Earnings per Share (EPS) is considered as an important financial tool, which measures and states the indication of profitability of a company.
It is calculated by dividing the company’s net income with its total number of outstanding shares.
This is a tool that market participants use frequently to gauge the profitability of a company before buying its shares.
EPS indicates how much money a company makes for each share of its stock and is a widely used metric for corporate profits.
The resulting number serves as an indicator of a company’s profitability. It is common for a company to report EPS that is adjusted for extraordinary items and potential share dilution.
The higher a company’s EPS, the more profitable it is considered.
EPS can be arrived at in several forms, such as excluding extraordinary items or discontinued operations, or on a diluted basis.
Let’s get in deep to understand the functions of EPS.
- EPS is the portion of a company’s profit that is allocated to every individual share of the stock.
- It is a term that is of much importance to investors and people who trade in the stock market.
- The higher the earnings per share of a company, the better is its profitability.
- While calculating the EPS, it is advisable to use the weighted ratio, as the number of shares outstanding can change over time.
Earnings per share can be calculated in two ways
1) Earnings per share: Net Income after Tax/Total Number of Outstanding Shares
2) Weighted earnings per share: (Net Income after Tax – Total Dividends)/Total Number of Outstanding Shares.
A more diluted version of the ratio also includes convertible shares as well as warrants under outstanding shares.
It is considered to be a more expanded version of the basic earnings per share ratio.
For an investor who is primarily interested in a steady source of income, the EPS ratio can tell him/her the room a company has for increasing its existing dividend.
Although, EPS is very important and crucial tool for investors, it should not be looked at in isolation. EPS of a company should always be considered in relation to other companies in order to make a more informed and prudent investment decision.
Now let’s move towards by understanding the formula and calculation of EPS:
Formula and Calculation of EPS
The earnings per share value are calculated as the net income (also known as profits or earnings) divided by the available shares.
A more refined calculation adjusts the numerator and denominator for shares that could be created through options, convertible debt, or warrants.
The numerator of the equation is also more relevant if it is adjusted for continuing operations.
The formula is mentioned below:
Earnings Per Share (EPS) = (Net Income – Preferred Dividends) / Total Number of Outstanding Shares
To calculate a company’s EPS, the balance sheet and income statement are used to find the period-end number of common shares, dividends paid on preferred stock (if any), and the net income or earnings.
It is more accurate to use a weighted average number of common shares over the reporting term because the number of shares 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.
Some data sources simplify the calculation by using the number of shares outstanding at the end of a period.
Understanding Earnings per Share
The earnings per share metric are one of the most important variables 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 see the value of a stock in terms of how much the market is willing to pay for each dollar of earnings.
EPS is one of the many indicators you could use to pick stocks. If you have an interest in stock trading or investing, your next step is to choose a broker that works for your investment style.
Comparing EPS in absolute terms may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings.
Instead, investors will compare EPS with the share price of the stock to determine the value of earnings and how investors feel about future growth.
Basic EPS 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 shares that could be issued by the company.
When the capital structure of a company includes items such as stock options, warrants, restricted stock units (RSU), these investments if exercised could increase the total number of shares outstanding in the market.
To better illustrate the effects of additional securities on per-share earnings, companies also report the diluted EPS, which assumes that all shares that could be outstanding have been issued.
Sometimes an adjustment to the numerator is required when calculating a fully diluted EPS.
The shares that would be created by the convertible debt should be included in the denominator of the diluted EPS calculation, but if that happened, then the company wouldn’t have paid interest on the debt.
In this case, the company or analyst will add the interest paid on convertible debt back into the numerator of the EPS calculation so the result isn’t distorted.
EPS Excluding Extraordinary Items
Earnings per share can be distorted, both intentionally and unintentionally by several factors.
Analysts use variations for the basic EPS formula to avoid the most common ways that EPS may be inflated.
Imagine a company that owns two factories that make cell phone screens. The land on which one of the factories sits has become very valuable as new developments have surrounded it over the last few years.
The company’s management team decides to sell the factory and build another one on less valuable land. This transaction creates a windfall profit for the firm.
While this land sale has created real profits for the company and its shareholders, it is considered an “extraordinary item” because there is no reason to believe the company can repeat that transaction in the future.
Shareholders might be misled if the windfall is included in the numerator of the EPS equation, so it is excluded.
A similar argument could be made if a company had an unusual loss maybe the factory burned down which would have temporarily decreased EPS and should be excluded for the same reason.
The calculation for EPS excluding extraordinary items is:
EPS= (Net Income – Preferred Dividends (+ or -) Extraordinary Items) / Weighted Average Common Shares
EPS from Continuing Operations
A company started the year with 1000 stores and had an EPS of Rs10.00. However, assume that this company closed 200 stores over that period and ended the year with 800 stores.
An analyst will want to know what the EPS was for just the 800 stores the company plans to continue with into the next period.
In this example, that could increase the EPS because the 200 closed stores were perhaps operating at a loss.
By evaluating EPS from continuing operations, an analyst is better able to compare prior performance to current performance.
The calculation for EPS from continuing operations is:
EPS = (Net Income – Preferred Dividend (+ or -) Extraordinary Items (+ or -) Discontinued Operations) / Weighted Average Common Shares.
This is the complete information about the Earnings per Share that an investor or an analyst should know about.
Conclusion
From this article on “What is EPS in Stock Market?” details about the basic and important aspects, an investor or an analyst has to check when they use Earnings per Share.
For calculating the Price to Earnings ratio, the role of EPS is important so for getting the better and clear result one should have a sound knowledge about the Earnings per Share.
Lastly, I want to conclude the article by stating that EPS is an important part of making a decision by the investors or the analyst if they can go with the company for investment or not.
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