There’s no shortage of information when it comes to stocks. Headlines, financial reports, advice from friends—the list goes on and on. With so much information at our fingertips, it can quickly become difficult to know what to pay attention to. Looking to cut through the noise? Turn to a helpful metric such as “earnings per share.”

What is earnings per share?

Earnings per share (EPS) represents the portion of a company's profit allocated to each outstanding share of its common stock, quantifying a company's ability to generate earnings on a per-share basis and giving investors nuanced perspective on its financial performance and profitability. In other words, it tells you how successful a company is.

How to calculate earnings per share

The corresponding formula is relatively straightforward; you simply subtract preferred dividends from net income and then divide that number by the weighted average shares outstanding. The formula looks like this:

EPS = (Net Income – Preferred Dividends) / Weighted Average Shares Outstanding

· Net Income: Reflects the company's total profit after accounting for expenses, taxes, and interest

· Preferred Dividends: Dividends disbursed to preferred shareholders, who hold priority over common shareholders

· Weighted Average Shares Outstanding: Represents the average count of common shares outstanding throughout a specific period, adjusted for any alterations such as stock splits or repurchases

A quick example to help clarify…

Company ABC reports net income of $20 million for the fiscal year, with 10 million shares of common stock outstanding, and disburses preferred dividends totaling $2 million. In this case, EPS equals (20 million – 2 million) divided by 10 million. Thus, Company ABC has an earnings per share of $1.80 for the fiscal year.

Different earnings-per-share reporting strategies

Companies report earnings per share in different ways. We can think of this as three different “types” of earnings per share, each of which arm investors with useful information.

Basic earnings per share

Basic EPS, the simplest earnings-per-share calculation type, represents the portion of a company's profit attributable to each outstanding share of common stock: providing a straightforward measure of company profitability on a per-share basis and thus a key metric for investors when evaluating a company's financial health and performance.

Diluted earnings per share

Diluted EPS adjusts the earnings-per-share calculation to account for the potential dilution of existing shares due to the issuance of additional shares, stock options, convertible securities, or other potential dilution sources. Dilution occurs when additional securities are converted into common shares, potentially reducing earnings attributable to existing shareholders, and the formula for diluted EPS involves considering the impact of potential dilutive securities on earnings per share. This calculation assumes all potential dilutive securities are converted into common shares, resulting in a lower EPS figure compared to basic EPS.

Adjusted earnings per share

Adjusted EPS is a modified version of earnings per share that excludes certain one-time or non-recurring items, with these adjustments extending to asset sale gains/losses, restructuring charges, litigation expenses, or other non-operating items that may distort the true earnings picture: aiming to provide investors with a clearer view of a company's core earnings power by eliminating the impact of temporary or non-recurring factors.

Should a company provide more than one EPS number, which should you pay attention to? It all depends on how you plan to use this…

Comparing two different companies? You’ll obviously want to make sure you’re using comparable EPS numbers (basic and basic, diluted and diluted, etc.). Both basic and diluted EPS calculations use Generally Accepted Accounting Principles (GAAP), meaning calculations are standardized across companies. It’s preferable if both companies report diluted EPS in this case, but if not, utilize basic EPS instead.

Since adjusted EPS isn’t calculated using GAAP, this is preferable when comparing a company against itself (e.g., in calculating a company’s EPS over time, as it excludes one-time anomalies that may not speak to overall operations).

How and why to use EPS

Earnings per share is a valuable metric for a variety of reasons. Not only does it offer a concise measure of company profitability on a per-share basis—enabling investors to gauge earning power and financial health over time—but it’s also a useful comparison metric. By comparing EPS across companies within the same industry or sector, investors can discern which firms are more profitable than others: facilitating well-informed investment decisions. You can also use EPS in specific ways that perhaps apply more to some types of investors than others, as follows…

Value investors

A value investor is an individual who adopts an investment approach focused on identifying undervalued assets, seeking to purchase them at a discount relative to their intrinsic value and aiming to generate returns by holding these investments until the market recognizes their true worth.

These investors leverage metrics such as the price-to-earnings (P/E) ratio to do so, with this specific metric calculated by dividing stock price by EPS to evaluate whether a stock is undervalued or overvalued relative to its earnings. For example, if a company’s shares are worth $15 and its EPS is $0.75, it has a PE ratio of 20 (translated as “the company trades for 20 times its earnings”).

Growth investors

As growth investors seek to invest in companies with high growth potential, they can examine changes in EPS over sequential periods to gain insight into a company's growth trajectory; while a steadily rising EPS may signal robust growth potential, a declining EPS may warrant further scrutiny.

Dividend investors

Dividends are profits paid out to shareholders. Investors can calculate the dividend payout ratio to better understand a dividend’s financial stability, with this number calculated by dividing dividends per share by the EPS (for a given quarter or year). If the corresponding figure falls below 100%, this suggests the company can afford the dividend. Should the dividend payout ratio exceed 100%, meanwhile, the company may need to either borrow money or dig into some of its cash reserves to afford the dividend. Take this example…

Over the past year, Company ABC has paid out $0.20 per share in dividends and has an EPS of $0.25: resulting in a dividend payout ratio of 80%, suggesting it should be able to afford its dividend. Company XYZ, meanwhile, also paid out $0.20 per share in dividends over the last year but has an EPS of $0.15 (resulting in a dividend payout ratio of 133%). Should the latter company decide to proceed in the same manner, it won’t be able to afford its dividend.

Key earnings-per-share considerations

While EPS is often a useful tool, it is that and only that: a tool. EPS is by no means foolproof, and several crucial factors can impact the numbers. With this in mind, here are four key factors to consider:

1. Earnings quality

Not all earnings are created equal. Investors should therefore scrutinize the quality of company earnings including factors such as recurring vs. one-time income, accounting methodologies, and the potential for financial statement manipulation.

2. Dilution effects

Alterations in the number of shares outstanding, such as stock issuances or buybacks, can influence EPS. Dilution occurs when additional shares are issued, diluting EPS for existing shareholders and potentially impacting shareholder value.

3. Industry dynamics

Variations in industry norms and benchmarks can also influence EPS comparisons. Related factors such as capital intensity, profit margins, and growth prospects differ across industries: necessitating industry-specific evaluations accordingly.

4. Macroeconomic influences

External factors (e.g., economic conditions, market trends, and regulatory changes) can exert significant influence on company earnings and, consequently, its EPS. Investors should therefore contextualize EPS analyses within the broader macroeconomic landscape.

What is considered a “good” earnings per share?

While calculating EPS is fairly simple, slapping on a specific label of “good” or “bad” is much more difficult—principally because different investors are on the hunt for different things.

A value investor, for example, looking for a company whose PE ratios fall below those of comparable companies in that industry, would consider a company with a lower PE ratio “undervalued” and thus a good deal.

On the other hand, a growth investor is more likely to consider a company’s EPS “good” in relation to its EPS for the same quarter of the previous year: deeming a company worth investing in if year-over-year EPS growth exceeds that of comparable companies in the same industry or EPS grows more quickly than its share price.

Finally, dividend investors often seek out companies with dividend payout ratios lower than 80%. This is a general rule of thumb and exceptions do exist, but a ratio exceeding 80% often signals a company’s dividend is not sustainable over time.

Whether a company’s EPS qualifies as “good” or not can also depend on estimates and may lead to major market movements.

EPS estimates and market reactions

Publicly traded companies are required by law to release financial statements on an ongoing basis (typically quarterly). Analysts and investors consider boatloads of information in these quarterly reports, but EPS in particular.

Analysts, financial institutions, and investors often formulate EPS estimates—benchmarks against which a company’s actual earnings are evaluated—based on various factors including company guidance, industry trends, economic conditions, and past performance. EPS estimates can influence market sentiment and investor expectations; if a company is expected to meet or exceed its EPS estimates, it may bolster investor confidence and positive sentiments, potentially driving up the stock price.

When a company reports its quarterly or annual earnings, meanwhile, it compares its actual EPS to the consensus EPS estimate. An actual EPS that exceeds the consensus estimate is considered an EPS “surprise” or “earnings beat,” whereas one that falls short of expectations may be deemed an “earnings miss.”

EPS surprises can trigger significant market reactions, with share prices often experiencing sharp movements in response to earnings beats or misses. While positive surprises may lead to stock price appreciation—as investors react positively to better-than-expected earnings performance and grow more confident in company management and growth prospects—negative surprises may erode investor confidence and raise concerns about the company's financial health and operational efficiency. Investors may thus reassess their expectations and adjust their valuation models accordingly, driving down stock price.

In sum: earnings per share

EPS gives investors keen insight into company profitability and potential growth prospects. By understanding how to calculate and interpret EPS, they can make more informed investment decisions, assess relative stock valuations, and construct well-rounded investment portfolios. Nonetheless, investors should also exercise prudence and consider factors such as earnings quality, dilution effects, industry dynamics, and macroeconomic influence—and always bring any questions they may have about EPS to a financial advisor to understand corresponding portfolio impacts.

Still have questions about earnings per share and how to use them? Schedule a FREE Discovery call with one of our financial advisors.

Earnings Per Share: What It Is and Why it Matters