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Earnings per share (EPS) consists of net income divided by the available shares. EPS is used as a metric to price equities, and provides a measure of the profitability of a company, divided by the number of shares outstanding. Analysts track the earnings per share to ensure they are investing in profitable businesses.
EPS can be calculated with a simple formula:
Because many companies pay dividends, this formula is normally calculated:
A few other variants exist, but the basic principle is the same. EPS measures the profitability of a company on a per share basis – so shares with a higher EPS will be in theory more valuable. In practice, trends in profitability are often more important than the raw number, and in some sectors (especially the technology sector during its 2010 – 2020 heyday) earnings are more or less ignored.
EPS gives an idea of the earning potential of a stock. It is used to calculate the P/E ratio, an all-important metric for fundamental investors. When the EPS is higher, it indicates that the share offers relatively larger stake in a more profitable business, one in theory that can be expected to outperform. In practice, non-fundamental or even frankly irrational factors can drive prices for long periods.
There are two variants of EPS – diluted and basic. Basic EPS is calculated as described above, but since corporate structures often include the potential to issue new shares, such as restricted share classes only held by insiders. These could potentially dilute the earnings of each public share, so the diluted EPS will calculate outstanding shares as if 100% of potential shares have been issued.
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