Earnings per share (EPS)

Definition

Earnings per share (EPS) is a financial metric that calculates the portion of a company’s profit allocated to each outstanding share of its common stock.

What is earnings per share?

It is often used as an indicator of a company’s profitability and is calculated by dividing the company’s net earnings by the number of outstanding shares. EPS provides insight into how much profit a company generates for each share of its stock, which can be useful for investors and analysts evaluating a company’s financial performance.

Earnings per share is calculated using the formula:

ESP = Net income / Number of outstanding shares

A good earnings per share depends on the context of the industry and the company’s historical performance. Generally, a higher EPS indicates better profitability and is often seen as a positive sign by investors. However, what constitutes a good EPS varies widely across sectors due to differences in business models, market conditions, and growth potential. Comparing a company’s EPS with its competitors and its own past performance can provide better insight.

Limitations of earnings per share

Earnings per share has several limitations. It does not account for the capital structure of a company, which means it can be skewed by share buybacks or stock issuances. EPS also doesn’t reflect the company’s cash flow, as it is based on accounting earnings, which can be influenced by non-cash items and accounting policies.

It doesn’t consider the growth potential of the company or the overall market conditions. Additionally, EPS can be manipulated through accounting practices, such as changing depreciation methods or recognising revenue early. For a comprehensive analysis, EPS should be evaluated alongside other financial metrics.

Basic EPS vs. diluted EPS

Basic EPS and diluted EPS are both measures of a company’s profitability per outstanding share of common stock. Basic EPS calculates earnings available to common shareholders divided by the number of shares outstanding. Diluted EPS adjusts this calculation to account for potential dilution from convertible securities like stock options, convertible preferred stock, or warrants that could potentially be converted into common shares.

Diluted EPS reflects the worst-case scenario for EPS if all potential dilutive securities are converted. Investors often consider both measures to understand the potential impact of dilution on earnings per share.

Example of earnings per share

Let’s consider a fictional company, XYZ Corporation, to illustrate earnings per share (EPS).

XYZ Corporation has a net income of £1 million for the fiscal year. The company has 500,000 outstanding shares of common stock.

So, the earnings per share for XYZ Corporation would be £2. This means that for each share of common stock, the company earned £2 in profit during that fiscal year.

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