The outstanding share of the common stock that has the portion of the company’s profit allocated to it is called Earnings PerShare (EPS). The company’s profitability is measured by the EPS. EPS can be calculated by using the balance sheet and income statement to scourge the dividends, preferred stock, the shares outstanding, net income, and the profit value. Since the number of shares outstanding can change over time, it is prudent to use a weighted number of shares outstanding over the reporting term. There should be a reflection of the stocks and dividends in the calculation of the weighted average number of shares outstanding. It can be simplified by using the shares at the end of a period.
The difference between basic and diluted EPS
- The formula usually considered to calculate EPS is the Basic EPS formula. Basic EPS does not account for the dilutive effect that is caused by additional securities. The total number of shares outstanding in the market for a company will increase if the capital structure of the company including investments, stock options, warrants, restricted stock units is exercised.
- The diluted EPS can be calculated at Stock Earnings,which companies can use to factor in the effects of additional securities on per-share earnings. Diluted EPS also includes the convertible securities in the outstanding shares numbers. It can be said that diluted EPS is the worst case scenario for a company because it converts certain securities to common stock which reduces the overall value of the company.
The need for earnings per share
- EPS is important in determining the price of a share. It is a predominant factor in calculating the price of a single share of a company.
- The price to earnings ratio denoted by (P/E) where ‘E’ stands for EPS is dependent on the value of EPS.
- An investor can gauge the level of water a company is in because EPS helps the investor in determining the fair value of the market stock and also the price that the market will pay for the stock based on the current earnings of the company.
- Since it breaks down a firm’s profits on a per share basis, EPS is considered an important entity in calculating a company’s value. What gives EPS its eminence is the fact that it gives crucial insight to an investor as outstanding shares of the company can change and the total income of the company can’t fully determine the company’s profitability.
- It is a metric used to measure the company’s profitability per unit shareholder. It is considered as the key driver of share prices.
- The division of EPS can be done based on the time period. The profitability of the company can be calculated through prior earnings, recent earnings or current earnings, or earnings predicted in the future.
However, one must remember that even though EPS is a strong quantifier as a company’s metric of profitability, it can be easily manipulated by restatements and accounting changes. Most people consider ‘free cash flow’ as a better measure of profitability.