What is EPS (Earnings Per Share)? EPS, "Earnings per share is a common financial indicator used by shareholders to assess a company's financial health. EPS is the amount of a company's profit that can be put towards each share of its common stock that is still outstanding. It is found by dividing the company's net income by the number of shares still in circulation. EPS is a crucial metric for investors because it shows how well a company is doing financially and how profitable it is. When a company's earnings per share (EPS) are high, it typically signifies that the stock price and dividends paid out to investors are also high. A lower EPS could mean that a company is having trouble making money. EPS is also essential because it lets companies in the same industry compare their profitability.
Calculation of EPS
Net income is divided by the number of outstanding shares to arrive at EPS. Earnings per share (EPS) is determined using the following formula:
EPS = (Net Income - Preferred Dividends) / Average Number of Shares Outstanding
The net income in the calculation is typically taken from a company's income statement. Preferred dividends are subtracted from the net income because they are paid to preferred shareholders before common shareholders. The average number of shares outstanding is calculated by taking the sum of the beginning and ending several shares outstanding and dividing by two.
Types of EPS
Earnings per share (EPS) may be either "essential" or "diluted."
Basic EPS
Unlike non-essential EPS, which takes into account dilutive instruments like stock options and convertible bonds, essential EPS only uses the number company outstanding common shares. When there are no dilutive securities, the simpler computation is essential EPS.
Diluted EPS
Diluted EPS considers the potential dilution from other securities, such as stock options or convertible bonds. Diluted EPS is calculated assuming all dilutive securities are converted into common shares. The calculation of diluted EPS is more complex than essential EPS and requires additional information about the potentially dilutive securities.
Importance of EPS
Earnings per share (EPS) is a key indicator of a company's financial health and development prospects. A higher EPS indicates a more profitable company, which may lead to higher stock prices and shareholder dividends. Conversely, a lower EPS may suggest a company struggles to generate profits.
EPS is also essential because it can be used to compare the profitability of different companies in the same industry. For example, if two companies have similar revenues, but one has a significantly higher EPS than the other, it may indicate that the higher EPS company is more efficient at generating profits.
Factors that can impact EPS
Several factors can impact a company's EPS.
Revenue
Revenue is a crucial driver of EPS because it is the source of a company's income. Companies with higher revenues generally have higher EPS.
Cost of Goods Sold (COGS)
COGS is the cost of producing and selling a company's products or services. Higher COGS can reduce a company's EPS because it reduces the amount of net income that can be allocated to each share.
Operating Expenses
Operating expenses include expenses such as salaries, rent, and utilities. Higher operating expenses can reduce a company's EPS because they reduce the net income allocated to each share.
Interest and Taxes
Interest and taxes can also impact a company's EPS. Higher interest expenses and taxes can reduce a company's net income, reducing the amount of net income allocated to each share.
Conclusion
Earnings per share (EPS) is often used by investors as a proxy for a company's success and development prospects. It measures the amount of a company's profit that can be allocated to each outstanding share of its common stock. Both basic and diluted EPS may be determined by dividing the net income by the number of outstanding shares. EPS is critical because it provides valuable information to investors about a company's financial health and can be used to compare the profitability of different companies in the same industry. However, there are also limitations to EPS, including the potential for manipulation and the fact that it does not consider the quality of earnings or risk.EPS is a valuable tool for investors. Still, it should be one of many metrics used to evaluate a company's potential for investment.
