Earnings Per Share (EPS)
Earnings Per Share (EPS) is a company's net profit divided by the number of outstanding common shares, calculated as (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding. It is a key metric for evaluating profitability and stock valuation.
Exam Tip
EPS = (Net Income - Preferred Dividends) / Weighted Avg Shares. Stock buybacks INCREASE EPS. Used to calculate P/E ratio. Diluted EPS includes convertible securities.
What is Earnings Per Share (EPS)?
Earnings Per Share (EPS) measures a company's profitability on a per-share basis. It represents the portion of a company's profit allocated to each outstanding share of common stock and is one of the most widely used metrics for evaluating stock value.
EPS Formula
Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding
| Component | Description |
|---|---|
| Net Income | Company's total profit after all expenses and taxes |
| Preferred Dividends | Dividends owed to preferred shareholders (subtracted because EPS measures earnings available to common shareholders) |
| Weighted Average Shares | Average shares outstanding during the period, accounting for buybacks and issuances |
Basic EPS vs. Diluted EPS
| Type | Formula | Use Case |
|---|---|---|
| Basic EPS | (Net Income - Preferred Dividends) / Weighted Average Shares | Standard profitability measure |
| Diluted EPS | (Net Income - Preferred Dividends) / (Weighted Average Shares + Dilutive Securities) | "Worst case" scenario including stock options, convertible bonds |
Example Calculation
| Item | Amount |
|---|---|
| Net Income | $10,000,000 |
| Preferred Dividends | $500,000 |
| Weighted Average Shares | 2,000,000 |
| Basic EPS | $4.75 |
Calculation: ($10,000,000 - $500,000) / 2,000,000 = $4.75
EPS and the P/E Ratio
EPS is essential for calculating the Price-to-Earnings (P/E) ratio:
P/E Ratio = Stock Price / EPS
| Scenario | Stock Price | EPS | P/E Ratio |
|---|---|---|---|
| Company A | $50 | $5.00 | 10 |
| Company B | $100 | $4.00 | 25 |
A lower P/E may indicate an undervalued stock; a higher P/E may indicate growth expectations.
Factors Affecting EPS
| Factor | Effect on EPS |
|---|---|
| Increased Net Income | Increases EPS |
| Stock Buybacks | Increases EPS (fewer shares outstanding) |
| New Stock Issuance | Decreases EPS (more shares outstanding) |
| Stock Splits | Decreases EPS (more shares, proportionally lower) |
| Increased Expenses | Decreases EPS |
Limitations of EPS
| Limitation | Explanation |
|---|---|
| Accounting Manipulation | Can be affected by one-time items and accounting choices |
| Ignores Cash Flow | Profitable on paper doesn't mean cash-rich |
| No Context Alone | Must compare to peers, historical trends, and growth |
| Share Buybacks | Can artificially inflate EPS without real profit growth |
Exam Alert
Key points for securities exams:
- Basic formula: (Net Income - Preferred Dividends) / Weighted Average Common Shares
- Diluted EPS includes potential shares from convertible securities and options
- EPS is used to calculate P/E ratio (Stock Price / EPS)
- Stock buybacks INCREASE EPS by reducing shares outstanding
- Stock splits DECREASE EPS proportionally but don't affect total earnings
- Preferred dividends are SUBTRACTED because EPS measures earnings to COMMON shareholders
Study This Term In
Related Terms
Common Stock
SecuritiesCommon stock is a security representing ownership in a corporation, giving shareholders voting rights and potential dividends.
Preferred Stock
SecuritiesPreferred stock is a hybrid security with features of both stocks and bonds, offering fixed dividends and priority over common stock in liquidation.
P/E Ratio (Price-to-Earnings)
SecuritiesThe P/E ratio is a valuation metric comparing a company's stock price to its earnings per share, used to assess whether a stock is overvalued or undervalued relative to its earnings.
Dividend
SecuritiesA dividend is a distribution of a portion of a company's earnings to shareholders, typically paid quarterly in cash or additional shares.