EPS (Earnings Per Share) reflects how much money a company makes per each share and is a widely used evaluation metric. EPS is essentially a company's profit divided by its number of common outstanding shares.
Formula 1
The balance and profit and loss statement offer the necessary data for calculation, namely number of common shares as of the end of the period, net income, and preferred dividends (if any).
Earnings Per Share = Net Income / Total Number of Outstanding Shares
- The practice of using the weighted-average shares (basic & diluted) for a certain time period to make calculation is considered to be more accurate (time limit gets eliminated).
- This method is used to book the share split/dividend on them for the reporting period.
- EPS is sometimes adjusted for extraordinary items and preferred dividends. Preferred stockholders typically have priority over common stockholders in terms of dividends.
- In essence, extraordinary items are events which the company considered to be rare in nature and unusual. Profits and losses arising in connection therewith are disclosed in the financial statements separately for the time period during which they happened.
EPS Formula in Terms of Preferred Dividends and Extraordinary Items
Formula 2
Earnings Per Share = (Net Income - Preferred Dividends - Extraordinary Items) / Total Number of Outstanding Shares
There are two main types of EPS:
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Example 1. ZOOM. Basic EPS
Basic EPS:
- Basic EPS focuses only on the total value of common outstanding shares.
- Basic EPS does not reflect share or conversion.
For the time period that ended on October 31, 2020:
- Zoom’s net income totals $198.44 m.
- 284.78 m common outstanding shares.
EPS = $198.44 / 284.78 = $0.70
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Example 2. ZOOM. Diluted EPS
- Diluted EPS is aimed at dilution resulting from a share split that affects the EPS value.
- Following the exercise of options, warrants and convertible options, the total number of shares typically increases which, in turn, makes EPS drop.
- Diluted EPS is always less than (or equal to) its basic EPS. It includes shares that are not currently outstanding but which may be issued at a later date (in cases where share options and other securities are exercised).
- This is an essential indicator for businesses that have a complex capital structure.
For the time period that ended on October 31, 2020:
- Zoom’s net income totals $198.44 m.
- 284.78 m common outstanding shares.
- Average number of Zoom’s diluted shares that were outstanding in the course of quarter amounted to 299.26 m.
Diluted EPS = $198.44 / 299.26 = $0.66
As comliared to EPS of $0.66 in January 2020 (when the stock traded at $75), we are witnessing a significant growth of the company.
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Norm
Traditionally, the higher EPS means the company has sufficient profitability. Aside from that, a high level of EPS typically indicates a higher share price. Investors are willing to pay more assuming that the company is able to achieve higher returns in terms of stock price.
The thing is that the EPS has an absolute value. It demonstrates the specific earnings per share in a particular currency. This aspect must always be factored in when performing a comparative analysis of companies and industries’ EPS. That’s exactly why the statement saying that a higher EPS always reflects an additional advantage of the company would be inaccurate in this context.
Example 3. Zoom и AТ&T
To gain a better understanding of EPS and its analysis, we shall consider the example of two telecommunication companies, namely Zoom and AТ&T.
1. To this end, we will use Diluted EPS (TTM) (which you can simply look up in stock exchange bulletins):
- Zoom’s Diluted EPS (TTM) = 1.44.
- AT&T’s Diluted EPS (TTM) = 1.52.
As you can see, the EPS values are not too different. However, this in no way cannot point to any particular advantages until we actually check out the stock prices of these issuers.
2. Let’s find out a stock price (as of December 10, 2020):
- Zoom price = $385.96.
- AT&T’s price = $31.46.
3. Now let’s take a look at the price-earnings ratio (P/E):
- Zoom P/E ratio = 385.96 / 1.44 = 268.02.
- AT&T’s P/E ratio = 31.46 / 1.52 = 20.7.
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As we can see, Zoom shares are, in fact, extremely overvalued. Zoom’s P/E ratio is lagging behind the majority of its competitors from the same sector. Based on results of the overall evaluation, AT&T shares are much more attractive to investors.
Drawbacks
- EPS indicator provides a quick insight into profitability but it must be considered jointly with cash flow and other indicators.
- Stock buybacks distort the EPS.
- Stockholders do not have direct access to net income and its distribution despite publicly available information.
- In the broad context, EPS does not factor in financial leverage (there is no way the investors can know what impact it has on profit).
- EPS can be easily manipulated by adjusting depreciation and amortization rate or non-recurrent items.
- One of the aspects that often gets undeservedly ignored is equity. In this case, ROE will serve as the indicator that will demonstrate the company’s performance to the fullest extent.
Let’s Sum Things Up
- EPS helps investors understand the return they can expect.
- This is an essential indicator when it comes to industry analysis.
- High EPS depends on a variety of factors, such as analysts’ forecasts, actual business performance, competitors' performance, etc.
- In order to perform a comprehensive analysis, we recommend evaluating EPS in terms of the stock price through the prism of P/E ratio or yield.
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