Diving Deep into Earnings Per Share (EPS)
EPS is a fundamental measure of a company's profitability on a per-share basis, making it easy for investors to understand how much profit the company is generating for each share they own.
Formula and Calculation
There are two main types of EPS:
-
Basic EPS:
Basic EPS = (Net Income - Preferred Dividends) / Average Outstanding Common Shares
-
Diluted EPS: This is a more conservative measure that includes the impact of all dilutive potential shares (e.g., from stock options, warrants, and convertible securities).
Example: If a company has a net income of $10 million, no preferred dividends, and 5 million average outstanding common shares, the Basic EPS is:
$10,000,000 / 5,000,000 = $2.00 per share
Why EPS Matters
- Profitability Indicator: EPS is a direct measure of a company's profitability.
- Valuation: It's a key input for the P/E ratio, a common valuation metric.
- Growth Assessment: A history of consistent EPS growth is highly valued by investors.
Trailing vs. Forward EPS
- Trailing EPS: Based on the company's earnings over the past 12 months.
- Forward EPS: Based on analysts' estimates of the company's future earnings.
Both are useful, but Forward EPS is based on projections and may not be as reliable.
Cautions
While a high and growing EPS is desirable, investors should be cautious of companies that try to manipulate EPS through aggressive accounting or excessive share buybacks that are not supported by underlying business growth. Always look for sustainable earnings growth.