The Earnings Per Share explained.

Earnings Per Share (EPS) is an important financial metric that determines how much of a company’s accounting profit is allocated to each common share outstanding. The earnings of a company is one of the most significant variables in shaping a stock price. The EPS in used in other key financial and valuation ratios.

Investors use EPS to assess the performance and profitability of a company before investing. A higher EPS means the company is more profitable. The EPS tells a lot about the current and future profitability of a company. You don’t want to assess a company’s investment “worthiness” by looking at the earnings per share in isolation; instead, understand the changes in earnings per share ratio over time and if it is growing or shrinking as well as comparing it to its competitors.

As a shareholder you own a small slice of the bigger pie. The Earnings Per Share is attributed to your slice of the pie and the earnings (profit) it is entitled to. Earnings can be called net income, profits, or the bottom line. Every company has different equity structures and number of shares owned by the public. Comparing the earnings as a whole does not provide a clear indication of how much profit each of the shares earns, so the EPS is a good metric when comparing peers to one another.

Earnings are a company’s profits, which can be calculated by subtracting the total cost of producing a product from the revenue generated from its sale. Although the accounting details can be complex, earnings always refer to the amount of money a company earns after deducting all the expenses.

Sometimes there are businesses with no EPS value. They have yet to turn a profit, so their EPS is either nothing or on the odd occasion negative. Investors care about earnings because they ultimately drive stock prices. Strong earnings generally result in the stock price going up, declining earnings also contributes to a declining stock price.

What is the Earnings Per Share formula?

• EPS = Net Income – Preferred Dividends ÷ Weighted Average Shares Outstanding
• Net Income = Found on the income statements.

Most of this information is found either on financial websites or the company’s annual filings so working it out manually is usually never needed.

Net Income: The net income (bottom line) is the after-tax profits generated by a company once all operating and non-operating costs are deducted.

Preferred Dividends: A Preferred stockholder has a higher claim than common shareholders in a company’s equity structure. We must remove preferred distributions as EPS represents the earnings to common (not preferred) shareholders.

Weighted Average Shares Outstanding: Shares outstanding are the units of ownership issued by a company to date, minus the retired shares. We have to make adjustments for the changes in the share capital over a certain period. The weighted average is used to align the timing mismatch between the two components of the formula.

Basic EPS vs. Diluted EPS: Diluted EPS accounts for the net impact of potentially dilutive securities, while basic EPS does not. Investments like stock options, warrants, and restricted stock units (RSUs) could increase the total number of outstanding shares if exercised, impacting the capital structure of the company. As the Diluted EPS metric assumes that all these shares are issued the number is often lower than the basic formula.

There are 3 types of Earnings Per Share ratios.

1) The Trailing Earnings Per Share which is based on the previous year’s figures. This is most often used as it uses the real numbers that have been reported.

2) Current Earnings Per Share which is based on the current year’s figures including forecasts. Some quarters may be reported and some forecasted.

3) Forward Earnings Per Share which is the futuristic forecasted EPS that analysts use to help investors understand the profit of the company.

How to use EPS?

Earnings Per Share is crucial for investors to measure a company’s profitability, dividend potential and stock price. It helps calculate various financial metrics such as the price-to-earnings, monitor profit changes, and compare ratios with other companies.

Let’s look at an example of three investment opportunities all in the same industry to find which business is producing more Earnings Per Share.

EPS	Company A	Company B	Company C
Net Income	$980 million	$2.2 billion	$1.83 billion
Preferred Dividends	$0	$0	$295 million
WACS	575 million	1.5 billion	1.38 billion
Basic EPS	$1.70	$1.46	$1.11

So, in this example we can look at the 3 companies, and we see that Company A has a higher EPS of $1.70. For every share held, you would expect $1.70 of profit. We cannot immediately assume it is a better company purely based on this, it is a start to further investigate why it is performing better than the other two companies.

Companies that have a similar EPS need to be researched diligently. One company might have a more efficient use of capital and achieve the same earnings with less investment.

The EPS alone does not tell the story. We can see Company A is producing a better return on a per-share basis, but we need to dig deeper into understanding how that has evolved over time. A higher EPS can mean the company has the potential to be a more successful investment than the other two.

Company A	2021	2022	2023
Net Income	$806 million	$907 million	$980 million
Preferred Dividends	$0	$0	$0
WACS	555 million	560 million	575 million
Basic EPS	$1.45	$1.61	$1.70

In this highly simplified example we can start to see a picture forming. This is how I use the EPS myself; I lay it out in a simple method, looking at the net income, and changes in the share structure which is incredibly important especially when it comes to dilution (over dilution has a terrible impact on earnings per share). I will consider share buybacks which can fuel EPS as it is removing shares from the pool, so the earnings are divided up by a smaller “pie”.

As you go back and start to include previous years, the small yet sustainable and consistent growth in the EPS is something I am looking for. The same is true when laying it out and noticing a declining EPS, it warrants further due diligence. We are looking for positive trends.

How to Calculate the Weighted Average Shares Outstanding? Let us use a simple example. Assume a company starts the year with 75 million shares. Halfway through the year, the company issues 10 million shares to raise capital. We would then consider 75 million shares for the whole year and the 10 million shares issued for the last 6 months.

Our calculation would be WASO = (75m x 1) + (10m x 0.5) = 75,000,000 + 5,000,000 = 80 million.

In Summary…

Growing earnings is a measure of a company’s efficient performance and indirectly a measure of return for an investor. A higher EPS indicates greater value and investors will pay a higher share price if they think the company can produce higher profits per share.

When I am looking at EPS, I want to see it consistently increasing over several quarters or years which signifies sustainable growth, efficient management, and the makings of a competitive edge. Using the EPS with the P/E can help understand whether a stock is overvalued or undervalued. There is no “Good or Bad” EPS, it is about how the earnings fit into the bigger picture. We need to understand how it measures against the valuation of the business, other competitors, its consistency in the past and the growth prospects looking ahead.

A lot of early-stage or hyper-growth companies especially in the micro-cap and small-cap space don’t have any earnings. As a company gets closer to crossing the chasm and earning profit we can then begin to gauge what sort of earnings this business can generate which is where the forward EPS forecasts come in.

I believe earnings have become the core focus of most investors, waiting for analyst calls, and quarterly updates and are fixated on this. I don’t put so much emphasis on quarterly changes, as a long-term investor I like to look back and see to trend evolve over time. I do measure especially in certain industries such as retail and e-commerce this year’s quarter to the same quarter last year. This helps to look at changes over a year and not necessarily month by month.