## What is Earnings Per Share (EPS)?

Earnings Per Share (EPS) is another financial ratio that is used by companies to measure the profitability of each share of common stock, or the ability of a company to produce net profits from shares of common stocks.

To compute the EPS, companies normally divide the net earnings by the total shares of common stocks outstanding.

Investors look at the EPS and decide whether it is safe for them to invest in the company.

When the EPS is high, that gives a general indication that the company is profitable.

### Earnings Per Share Formula

The formula to compute for EPS is the Net Income less preferred dividends, and then divided by the weighted average shares outstanding.

The net income, preferred dividends and common shares outstanding can be found in the Income Statement and Balance Sheet of the company.

And because the common shares outstanding changes over an accounting period, the weighted average is normally computed.

EPS = (Net Income – Preferred Dividends) / Weighted Average of Shares Outstanding

EPS = (Net Income – Preferred Dividends) / End of Period Shares Outstanding

## Example of EPS

Suppose an investor is looking at investing in different companies belonging to the same industry and is undecided which one to invest in, they can calculate the EPS to get an idea of a company’s profitability on an absolute basis.

Below are the the data of three companies at the end of the reporting period:

 Company Net Income Preferred Shares Common Stocks (Weighted Average) ABC \$630,000.00 – 200,000.00 XYZ \$425,000.00 57,000.00 180,000.00 HIJ \$710,000.00 125,000.00 480,000.00

Based on the above example, the EPS of the three companies will be:

Company ABC = \$3.15 (\$630,000 / 200,000)

Company XYZ = \$2.04 ((\$425,000 – 57,000) / 180,000)

Company HIJ = \$1.22 ((\$710,000 – 125,000) / 480,000)

## Basic EPS vs. Diluted EPS

The difference between a Basic EPS and a Diluted EPS is that Basic EPS does not take into consideration the dilutive effect of common shares that a company issues.

Diluted EPS includes the value of stock options and convertible bonds should they be converted to common shares, and if they meet certain criteria.

The formula to compute for Diluted EPS is:

 Diluted EPS = Net Income – Preferred Dividends Weighted Average Shares Outstanding + Convertible Securities

Based on the example above, suppose that Company ABC and Company XYZ has convertible bonds that could be issued as common shares are the following:

 Company Net Income Preferred Shares Common Stocks (Weighted Average) Convertible Stocks ABC \$630,000.00 – 200,000.00 65,000.00 XYZ \$425,000.00 57,000.00 180,000.00 30,000.00 HIJ \$710,000.00 125,000.00 480,000.00 –

The Diluted EPS will be calculated as follows:

Company ABC = \$2.38 (\$630,000 / (200,000 + 65,000))

Company XYZ = \$1.75 ((\$425,000 – 57,000) / (180,000 + 30,000))

## EPS Excluding Extraordinary Items

Extraordinary items are either income or losses that have a low probability of ever happening again, and are generally considered to be infrequent or do not usually happen.

Because this can have a significant impact on the net income of a company and has the potential to be used to distort the calculation of EPS whether it is done voluntarily or involuntarily, it can have a direct impact on the EPS as well.

For this reason, extraordinary items are excluded in the computation of the EPS.

Without the extraordinary items, the formula of the EPS will be:

 EPS = Net Income – Preferred Dividends (+/-) Extraordinary Items Weighted Average Common Shares

## EPS From Continuing Operations

Computing for EPS from Continuing Operations helps companies evaluate the EPS of companies in case a company has closed down some of the operations of their business.

Naturally, closing down a part of the operations will cause the profit of the company to go down, but if the closed operations were operating at a loss, the EPS of the company will tend to be higher.

When the EPS from continuing operations is computed, the EPS prior to the discontinued operations and EPS after the discontinued operation can be analyzed comparatively.

 EPS = Net Income – Preferred Dividends (+/-) Extraordinary Items (+/-) Discontinued Operations Weighted Average Common Shares

### EPS and Capital

Capital dictates the efficiency of companies in maximizing the assets of the company to generate profit.

When making an analysis for two companies, they both could have more or less the same EPS but one company could be operating with more assets.

An addition to evaluating companies of the same industries apart from the EPS is the Return on Equity (ROE) to determine which company is more efficient.

### EPS and Dividends

The Earnings Per Share is a measure of profitability of a company and how much profit is generated for each share of its stock.

With the EPS, not all shareholders will have access to the earnings a company makes – some earnings are distributed as dividends, while part of the earnings are also retained by the company.

### EPS and Price-to-Earnings

The E in the Price to Earnings Ratio is the EPS, and P/E Ratio can be computed by determining the market value per share and dividing it by the EPS.

P/E Ratio is also called the earnings multiple or price multiple. The P/E Ratio is helpful when a company is making similar comparisons or when the company’s own records are compared against their historical data.

### Difference between basic EPS and diluted EPS

A Basic EPS is computed by simply dividing the Net Income by the Weighted Average of Common Shares.

Generally, the Diluted EPS can sometimes be equal to or less than the Basic EPS because the convertible securities are included in the equation.

### Difference between EPS and adjusted EPS

In the computation of Adjusted EPS, the Net Income is reduced by items that are non recurring.

For example, the company’s net income increases by the sale of one of their major assets.

Since this is not part of the company’s normal operations and does not happen often, the proceeds from the sale shall be reduced from the Net Income.

This in turn will cause the EPS to be lower.

## Limitations of EPS

There are some cases when companies can inflate the EPS and they can do so by buying back shares of stocks or reducing the common shares outstanding or by reverse splitting the stocks.

While the EPS provides information about the profitability of the company, it does not give a full picture of the financial performance unless it captures the price per share.

This is done through the computation of the rate of return.

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1. University of Maryland "A Theoretical and Empirical Study of Computing Earnings Per Share" White Paper. December 20, 2021

2. Columbia Law School "Mergers and the Role of Earnings-Per-Share" Page 1 . December 20, 2021

3. Penn State University " Earnings per share " Page 1 . December 20, 2021