Earnings per share(EPS) are the amount of net profit a company gains per share for a specific timeframe. This financial metric gives potential investors an idea of how profitable it will be to invest in this company's stock. It helps the company measure its economic performance. This article explains what earnings per share are and how to calculate them.
Earnings per share are the amount of net earnings a company makes for each of its shares. This monetary value provides current shareholders with a clear understanding of the earnings they will receive for each share they own.
A higher EPS is always better because it indicates the company is more profitable. Investors will pay more money to buy the company's shares due to higher profitability.
The basic formula of EPS is net income minus preferred dividends. Then, divide the calculation by the average outstanding shares.
Net income(NI) is calculated by subtracting the total earnings from all the expenses, operating costs, and taxes.
Preferred dividends are paid to preferred shareholders who have the right to receive the profit of a company before it is paid to common shareholders. Companies provide them with a fixed amount of dividends annually.
Average outstanding shares are the number of shares actively traded in the market.
For example, the net income of ABC LTD. is $1,000,000, preferred dividends are $250,000, and total outstanding shares are 1,100,000.
After subtracting preferred dividends from net income, we obtain $750,000 ($1,000,000 - $250,000). The earnings per share are $0.68 ($ 750,000 ÷ 1,100,000).
EPS is mainly of two types.
Under basic EPS, a company considers all the ordinary or common shares outstanding on average over a specific period. Basic EPS is always higher than diluted EPS.
Under diluted EPS, a company considers all the convertible shares. You can convert these shares into bonds, securities, warrants, or debt. Diluted EPS is always lower than Basic EPS.
EPS provides critical financial metrics to various groups of people. For instance,
Potential investors should not make decisions to buy shares in a company based solely on its EPS. It alone doesn't provide the complete financial health of a company.
For instance, a company sold some of its assets. You may achieve higher EPS only once during this particular period. The same company does not generate enough profit to provide even a dividend to its preferred shareholders.
Another example is that if a company buys back its own shares, the total number of outstanding shares will decrease. Hence, the EPS of the specific year will be higher. But once you purchase their shares, the EPS will decrease.
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