Earning Per Share (EPS)
What is it?
Earning per share, by its name implied, is the portion of a company’s profit in one single share of common stock. Earning per share is the mostly commonly used indicator among all investors to appraise the company’s performance. Of course, investors would also consider other financial factors in their investment decision, but a good track record of EPS would stand out significantly in the eyes of a strict fundamental analyst. The higher its EPS, the more appealing the company becomes to common investors.
How is it calculated?
EPS = (Net income – Dividends Paid)/ Share outstanding
What influences EPS?
Numerator: The higher the numerator, the higher its EPS. The numerator is determined by its revenue, or subsequently, its earning. The more revenue that the company generate, the higher its EPS.
Denominator: The lower the denominator, the higher the EPS. The denominator is determined by its common shares outstanding, the number of shares become smaller when the company decides to initiate the buyback program (a program that allows company to buy back its shares from the market). However, on the other hand, if the company decides to issue more common shares to the market, its shares outstanding will increase which decreases its EPS.
Basic vs diluted EPS
Basic EPS does not factor in dilutive effect of shares. Diluted shares consider the changes in the company’s shares. For example, if the company issues new shares, the basic shares will not show the changes, but diluted shares will show the changes in the company’s shares. When calculating the EPS, analysts often use diluted shares rather than basic shares, since it is a more accurate measurement of EPS.
P/E ratio: Analysts often use the calculated EPS to determine other financial indicators. One of the most commonly used price indicators to appraise the value of share prices is price per earning multiple (P/E). This ratio indicates how expensive the company’s shares is relative to its earning. A high P/E ratio would indicate that the stock is overvalued, and a low P/E ratio indicates that the stock is undervalued. A ratio that investors and analysts often consider “optimal” lies between 18 to 25. Anything above or below it would signal either undervaluation or overvaluation of the stock. The numerator of this ratio represents the current price of the company, and the denominator represents the earning per share (EPS)component that we learn how to calculate above.