What is Earnings per Share (EPS)?
By Nathan on The Capital
Earnings per Share or EPS is one of the most talked-about metrics when it comes to stocks. Analysts will often make predictions about a stock’s future Earnings per Share. But what is Earnings per Share?
What is Earnings per Share?
Earnings per share is a measure of how much earnings each share is worth. Earnings is another way of saying net profit. The higher the EPS of a company the more profit each share is worth.
How are Earnings per Share Calculated?
Earnings per share are calculated by dividing the net profit by the shares outstanding.
EPS =Net Profit / Shares outstanding
Example:
A company has a net profit of $10m
They have 1 million shares outstanding
Their EPS will equal $10
EPS = $10m /1m = $10 per share
What do Earnings per Share Tell Us?
Earnings per share tell us this.
For every share of the company I own, I will receive x dollars in earnings a year later.
Replace x with EPS and you get your answer
If a company has an EPS of 5 — For every share of the company I own, I will receive $5 in earnings a year later.
Can you compare the Earnings per Share of Two Companies?
Comparing one companies EPS to another company does not tell us much.
You might think that a company with an EPS of $5 would be better than a company with an EPS of 1 but that’s not how it works.
Example
We have two companies, Company A and Company B
Company A has a net profit of $50m and 50m shares outstanding
Company B has a net profit of $50m and 10m shares outstanding.
Company A has an EPS of $1 per share
$50m / 50m = $1
Company B has an EPS of $5 per share
$50m / 10m = $5
Company B has a higher EPS but both companies are the same. They both produce $50m in profit. The only difference is the number of shares outstanding.
It is highly likely that company A’s shares are much cheaper.
Example
A share of Company A costs $15
A share of Company B costs $75 per share
If you had $750 to invest which company would be better to invest in.
Company A with an EPS of $1 per share or Company B with an EPS of $5 per share.
For Company A you can afford to buy 40 shares
$750 / 15 = 50
For Company B you can afford to buy 10 shares.
$750 / 75 = 10
How much Earnings will you receive from each investment?
For company A you will buy 50 shares each generating $1 in EPS.
For company B you will be 10 shares each generating $5 in EPS.
Even though Company B has a much higher EPS the investment return is the same as Company A.
Earnings per share can be used to compare companies when you use it as part of the PE Ratio.
To learn about the PE ratio read my article What is the PE Ratio?
How does Earnings per Share impact stock Price?
Generally speaking, if Earnings per Share is increasing the stock price will increase as well.
Here we can see the comparison of Apple’s EPS and share price over the past 10 years.
Another way Earnings per Share can impact a stock price is due to investors' expectations.
Let's say investors expect a company to grow there EPS by $1 over the next year.
The company is only able to grow its share price by 90c.
This will usually result in the share price decreasing the day that earnings are announced.
What causes earnings per share to decrease?
As I have said earnings per share is calculated by dividing the earnings by the shares outstanding.
This means there are two ways that earnings per share can decrease.
Earnings per share will decrease if:
- Earnings (net profit) decreases
- Shares outstanding increases.
Earnings decreases.
Earnings will decrease if a company's expenses grow or if their sales decrease.
Let's say a company sells lemonade.
If the cost of lemons goes up then each glass of lemonade will be less profitable.
If the company cannot attract as many customers then their revenue will go down meaning fewer profits.
Shares outstanding increases.
The company may decide to issue more shares to the public.
If this happens this means there are more shares that the earnings need to be distributed to.
Where is earnings per share on the financial statement?
There are three Financial Statements
- The Income Statement
- The Balance Sheet
- The Cash Flow Statement
The Earnings per share can be found on the income statement
Here are the EPS I found on the Quarterly income statement for Apple.
To find the income statement of a company you can go to a website such as Yahoo Finance or Morningstar.
Alternatively, you can go directly to the companies website and download their Quarterly or Annual Reports.
Key Points
- Earnings per share is a measure of how much earnings each share is worth.
- EPS =Net Profit Shares outstanding
- For every share of the company I own, I will receive x dollars in earnings a year later.
- EPS on its own cannot be used to compare two companies
- Using EPS as part of the PE Ratio can allow us to compare two companies
- EPS and Share Price are closely related
- People's expectations of EPS growth can impact the share price.
- EPS can decrease if Earnings decreases or if Shares Outstanding increases
- The EPS can be found on the Income Statement.
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