Earnings Per Share (EPS): What It Means and How to Calculate It

What Is Earnings Per Share (EPS)?

Earnings per share (EPS) is a measure of a company's profitability that indicates how much profit each outstanding share of common stock has earned. It's calculated by dividing the company's net income by the total number of outstanding shares.

The higher a company's EPS, the more profitable it is considered to be.

Earnings Per Share Equation

Earnings per share value is calculated as net income (also known as profits or earnings) divided by available shares. A more refined calculation adjusts the numerator and denominator for shares that could be created through options, convertible debt, or warrants. The numerator of the equation is also more relevant if it is adjusted for continuing operations.

$\text{Earnings per Share}=\frac{\text{Net Income }-\text{ Preferred Dividends}}{\text{End-of-Period Common Shares Outstanding}}$Earnings per Share=End-of-Period Common Shares OutstandingNet Income − Preferred Dividends​

To calculate a company's EPS, the balance sheet and income statement are used to find the period-end number of common shares, dividends paid on preferred stock (if any), and the net income or earnings. It is more accurate to use a weighted average number of common shares over the reporting term because the number of shares can change over time. Understanding how to find EPS is crucial for evaluating a company's profitability.

Any stock dividends or splits that occur must be reflected in the calculation of the weighted average number of shares outstanding. Some data sources simplify the calculation by using the number of shares outstanding at the end of a period.

What Does Earnings Per Share (EPS) Indicate?

Earnings per share is one of the most important financial metrics employed when determining a firm's profitability on an absolute basis. It is also a major component of calculating the price-to-earnings (P/E) ratio, where the E in P/E refers to EPS. By dividing a company's share price by its earnings per share, an investor can see the value of a stock in terms of how much the market is willing to pay for each dollar of earnings.

Earnings per share shows an investor how to pick stocks, when used along with other indicators. If you have an interest in stock trading or investing, your next step is to choose a broker that works for your investment style.

Comparing EPS in absolute terms may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings. Instead, investors will compare EPS with the share price of the stock to determine the value of earnings and how investors feel about future growth.

Example of EPS

Say that the calculation of EPS for three companies at the end of the fiscal year was as follows:

Basic EPS vs. Diluted EPS

The formula in the table above calculates the basic EPS of each of these select companies. Basic EPS does not factor in the dilutive effect of shares that could be issued by the company. When the capital structure of a company includes items such as stock options, warrants, or restricted stock units (RSU), these investments—if exercised—could increase the total number of shares outstanding in the market.

To better illustrate the effects of additional securities on per-share earnings, companies also report the diluted EPS, which assumes that all shares that could be outstanding have been issued.

For example, say the total number of shares that could be created and issued from Company C's convertible instruments at fiscal year-end was 23 million. If this number is added to its total shares outstanding, its diluted weighted average shares outstanding will be 541 million + 23 million = 564 million shares. The company's diluted EPS is, therefore, $1.67 billion /.564 million = $2.96.

Sometimes an adjustment to the numerator is required when calculating a fully diluted EPS. For example, sometimes a lender will provide a loan that allows them to convert the debt into shares under certain conditions.

The shares that would be created by the convertible debt should be included in the denominator of the diluted EPS calculation, but if that happened, then the company wouldn’t have paid interest on the debt. In this case, the company or analyst will add the interest paid on convertible debt back into the numerator of the EPS calculation so the result isn’t distorted.

EPS Excluding Extraordinary Items

Earnings per share can be distorted, both intentionally and unintentionally, by several factors. Analysts use variations of the basic EPS formula to avoid the most common ways that EPS may be inflated.

Imagine a company that owns two factories that make cell phone screens. The land on which one of the factories sits has become very valuable as new developments have surrounded it over the past few years. The company’s management team decides to sell the factory and build another one on less valuable land. This transaction creates a windfall profit for the firm.

Though this land sale has created real profits for the company and its shareholders, it is considered an “extraordinary item” because there is no reason to believe the company can repeat that transaction in the future. Shareholders might be misled if the windfall is included in the numerator of the EPS equation, so it is excluded.

A similar argument could be made if a company had an unusual loss—maybe the factory burned down—which would have temporarily decreased EPS and should be excluded for the same reason.

The Formula for EPS Excluding Extraordinary Items Is:

$\text{EPS}=\frac{\text{Net Income }-\text{ Pref.Div. }\left(+or-\right)\text{ Extraordinary Items}}{\text{Weighted Average Common Shares}}$EPS=Weighted Average Common SharesNet Income − Pref.Div. (+or−) Extraordinary Items​

EPS From Continuing Operations

A company started the year with 500 stores and had an EPS of $5.00. However, assume that this company closed 100 stores over that period and ended the year with 400 stores. An analyst will want to know what the EPS was for just the 400 stores the company plans to continue with into the next period.

In this example, that could increase the EPS because the 100 closed stores were perhaps operating at a loss. By evaluating EPS from continuing operations, an analyst is better able to compare prior performance to current performance.

EPS and Capital

An important aspect of EPS that is often ignored is the capital that is required to generate the earnings (net income) in the calculation. Two companies could generate the same EPS, but one could do so with fewer net assets; that company would be more efficient at using its capital to generate income and, all other things being equal, would be a "better" company in terms of efficiency. A metric that can be used to identify more efficient companies is the return on equity (ROE).

EPS and Dividends

Although EPS is widely used as a way to track a company’s performance, shareholders do not have direct access to those profits. A portion of the earnings may be distributed as a dividend, but all or a portion of the EPS can be retained by the company. Shareholders, through their representatives on the board of directors, would have to change the portion of EPS that is distributed through dividends to access more of those profits.

EPS and Price-to-Earnings (P/E)

Making a comparison of the P/E ratio within an industry group can be helpful, though in unexpected ways. Although it seems like a stock that costs more relative to its EPS when compared to peers might be “overvalued,” the opposite tends to be the rule.

Regardless of its historical EPS, investors are willing to pay more for a stock if it is expected to grow or outperform its peers. In a bull market, it is normal for the stocks with the highest P/E ratios in a stock index to outperform the average of the other stocks in the index.

What Is Rolling EPS

Rolling EPS gives an annual earnings per share (EPS) estimate by combining EPS from the past two quarters with estimated EPS from the next two quarters.

It may be calculated with the following formula:

Rolling EPS = (Net income from the previous two quarters + next two quarters – preferred dividends) / average shares outstanding

Earnings per share (EPS), a company's profit divided by the amount of common stock it has in circulation, is one of the most closely observed metrics in investing. Other than serving as an indicator of how much money pulled in after accounting for all expenses was allotted to each share of common stock, it’s also frequently used to determine if a company is reasonably valued.

EPS is a key component of the price-to-earnings (P/E) valuation ratio. Divide the share price by EPS and you get a multiple denoting how much we pay for $1 of a company’s profit. In other words, if a company is currently trading at a P/E of 20x that would mean an investor is willing to pay $20 for $1 of current earnings.

The share price of a stock may look cheap, fairly valued or expensive, depending on whether you look at historical earnings or estimated future earnings.

Earnings forecasts are based on educated guesswork from analysts and are often too rosy, possibly making the valuation look cheap. Historical earnings, on the other hand, are set in stone but may not fairly represent a company's legitimate growth potential. Rolling EPS represents a compromise, giving investors a blend of both.

Rolling EPS vs. Trailing EPS

Rolling EPS shouldn’t be confused with trailing EPS, which mainly uses the previous four quarters of earnings in its calculation.

Sometimes you may hear or spot the term rolling trailing EPS, as well. What this means is that EPS will change as the most recent earnings are added to the calculation and earnings from five quarters ago are dropped to make way for them.

The Bottom Line

Earnings per share (EPS) is an important profitability measure used in relating a stock's price to a company's actual earnings. In general, higher EPS is better but one has to consider the number of shares outstanding, the potential for share dilution, and earnings trends over time. If a company misses or beats analysts' consensus expectations for EPS, its shares can either crash or rally, respectively.