What is the earnings per share (EPS)?
Earnings per share (EPS) is an important metric when investing in stocks. In this article, you will learn what EPS is and how to calculate it!
Earnings per share indicates how much profit is generated per share. This figure is useful because it shows how much of the company’s profits is allocated to the stocks you own. EPS also provides an indication of the maximum amount of dividend that can be paid per share.
You can easily calculate earnings per share by following these steps:
- Determine the company’s net income.
- Determine the number of outstanding shares.
- Divide the net income by the number of outstanding shares.
The following example illustrates how this works:
- A company has a net income of €1,000,000.
- There are a total of 1,000,000 shares outstanding.
- EPS = €1,000,000 / 1,000,000 = €1
Note: When calculating EPS, subtract the dividend paid to preferred stockholders first. If $100,000 was paid in dividends to preferred stockholders in the example, the EPS would be calculated as follows: ($1,000,000 – $100,000) / 1,000,000 = $0.90.
EPS is an important indicator for analyzing a company’s results:
- You can use EPS to compare the company with similar companies in the same sector.
- You can also use EPS to compare the company’s profits over different years.
- EPS can be used to calculate a company’s price-to-earnings ratio.
What is diluted EPS?
Diluted EPS is the earnings per share when all contingent securities are exercised. Contingent securities are securities that can be converted into shares. Examples include outstanding options or convertibles.
Beware of unusual gains and losses
Unusual gains and losses can distort EPS. Examples include:
- Unusual gain: a one-time sale of an expensive factory.
- Unusual loss: the destruction of a produced rocket.
You can exclude these one-time gains and losses when calculating EPS.
EPS and required capital
Not every company is equally efficient:
- Company A: has an EPS of $1, but uses $1,000,000 in capital to achieve this.
- Company B: has an EPS of $1, but uses $10,000,000 in capital to achieve this.
Company A is more efficient in this case and therefore a better choice. Do you want to know the result on capital? Then you can calculate the return on equity (ROE).
Limitations of the WPA
The WPA says little about the quality of the stock. You cannot directly determine with the WPA whether a stock is undervalued or overvalued. Consider the following:
- A company can buy back some of its shares, which causes the WPA to increase.
- By rearranging the accounting, the WPA can increase.
You can calculate a company’s earnings per share to determine whether to invest in this organization, but you can also take it a step further. You can choose to determine the weighted earnings per share. This calculation is more accurate because the calculation also takes the dividend paid to shareholders into account
To calculate the weighted earnings per share, first determine the dividend on the preferred shares. Then take the net profit of the company. Subtract the dividend of the preferred shares from this amount. You should divide the difference by the number of outstanding shares.
For example, an organization realized 50 million in profit. In that year, the company had 1 million outstanding shares and 5 billion in dividends was paid out. The earnings per share in this calculation is $50. However, the weighted earnings per share is lower, namely $45.
Frequently Asked Questions about WPA
There is no single WPA benchmark, as this strongly depends on the type of company and the sector. Whether a share rises or falls when reporting earnings per share often depends on expectations. A company with a positive WPA can still experience declining stock prices when an even better WPA was expected.
This is certainly not always the case! When the WPA per share is low, there may be a high price-earnings ratio. Investors are then willing to pay many times the share price. They only do this when they expect strong growth within the company, which is a sign of confidence.
The adjusted WPA removes one-time costs and losses from the calculations.
