Earnings Per Share (EPS) – Definition, Calculation, Formula

Earnings per share is defined as a company’s total profit divided by the number of shares outstanding.

Typically, the profit figure used is what is known as net profit. That is the company’s profit after all expenses, including operating expense, interest paid on borrowings, and taxes. 

Companies will sometimes report “adjusted” EPS. That figure uses net profit adjusted for one-time factors such as fees related to a merger, or other unusual costs. It may also exclude the cost of share-based compensation for employees, since that compensation can vary widely from year to year.

Whether adjusted or unadjusted (also known as GAAP net profit, as its calculation confirms to Generally Accepted Accounting Principles), the “earnings” in “earnings per share” almost exclusively refers to net profit.

The “share” referred to in earnings per share, however, can change. Companies generally report both basic earnings per share and diluted earnings per share.

For both basic EPS and diluted EPS, the earnings figure should be the same. What changes is the share count. A basic share count equals the average count of only the shares that are issued and outstanding during the period.  

This does mean that basic share count will change from period to period. If a company repurchases shares, its share count will decline, which reduces basic share count during that period. If, in contrast, it issues shares to employees or in consideration for an acquisition, the share count will increase. 

To calculate basic earnings per share, investors use a simple formula: earnings for the period (usually either a quarter or year) divided by the basic share count for the same period.

Earnings per share formula:

In this formula,

• Net Income: The company’s total profit, after deducting all expenses, taxes, and interest.
• Preferred Dividends: Dividends that are paid to preferred shareholders, which are subtracted from the net income to determine the earnings available to common shareholders.
• Outstanding Shares: The total number of shares of stock currently held by all shareholders, including institutional investors, insiders, and retail investors.

The basic EPS calculation can also be expanded in more complex cases to account for stock options and convertible securities, leading to a diluted EPS.

The diluted earnings per share formula is the same: net profit for the period divided by the diluted share count.

The diluted share count differs from the basic share count in that it adds shares that aren’t yet issued — but could be. For instance, executives may have stock options that are “in the money”; in other words, it would be profitable to exercise those options and turn them into shares. But basic share count does not account for those options, or for warrants (which function much like options).

Diluted share count gives a fuller picture of equity ownership. It includes not only those shares already issued, but those that likely will be in the future. It adds shares to the count usually based on the treasury stock method, which accounts for the cash that would be generated by the company through option and/or warrant exercise.

It’s worth noting that not all potential equity stakes are included in the diluted share count or in diluted EPS. Options and warrants can be excluded as “anti-dilutive” for two very different reasons.

First, the exercise price of the options or warrants may be above the trading price. In that case, the shares underlying the options are excluded because, at the moment, they are not going to be exercised. 

Second, the company can be unprofitable. In that case, the options are excluded because they would increase the diluted share count — and thus actually decrease the loss per share. In that event, the higher diluted share count is making the business look better than it might otherwise be. The accounting rules applied to diluted shares aim to prevent that outcome.

A simple example may be instructive. 

For a full year, ABC Corporation generates $10 million in net income. Its basic share count is 10 million. ABC also has 1 million stock options outstanding with an exercise price of $10, while its stock trades at $20.

Basic EPS for ABC, for the year, is calculated by dividing earnings by basic share count. In this case, that means $10 million divided by 10 million shares, or $1.00 even. 

Diluted EPS is a bit trickier. Again, there are 1 million options outstanding, which would bring in $10 million in cash. The exercise of those options would add 1 million shares to the basic count. In theory, however, ABC could acquire 500,000 shares with the $10 million in proceeds. 

And so diluted share count equals 10 million shares plus another 500,000 (the 1 million shares underlying options, less than 500,000 theoretically repurchased). Diluted EPS is calculated by dividing the $10 million in net profit by the 10.5 million in diluted shares, giving a result of 95 cents.

Now, if ABC is unprofitable, the math changes somewhat. If it loses $10 million with 10 million shares outstanding, basic loss per share is $1.00 even. But the outstanding options — whether in the money or not — do not affect diluted share count. Again, they are anti-dilutive; if they were added to the diluted share count, loss per share would improve slightly, to $0.95.

In this model, basic and diluted share count are the same. And so basic and diluted earnings per share are the same: a loss of $1.00.

To make things clearer, let’s walk through a simple example.

Suppose a company has a net income of $1,000,000 for the year, and it pays $100,000 in preferred dividends. The company has 500,000 outstanding shares.

The EPS would be calculated as follows:

EPS = (1,000,000 − 100,000) / 500,000

EPS = 900,000 / 500,000 = 1.80

Thus, the Earnings Per Share (EPS) is $1.80. This means that for every share of the company, investors are entitled to $1.80 of the company’s earnings.

Earnings Per Share is a critical measure for both investors and analysts, as it provides insights into a company’s profitability, financial health, and overall performance. Investors use EPS to gauge how well a company is performing relative to its peers, which is essential for making informed decisions.

Here are five reasons why EPS is so important:

Valuation Indicator
EPS serves as a key indicator of a company’s value. Investors typically compare EPS with the share price to calculate the Price-to-Earnings (P/E) ratio, which helps in assessing whether a stock is overvalued or undervalued.

Profitability Measure
EPS provides a snapshot of how efficiently a company is generating profit relative to the number of shares outstanding. A consistent increase in EPS over time is often a sign of a profitable and well-managed company.

Comparative Benchmark
EPS is a critical benchmark for comparing companies within the same industry. Companies with higher EPS are often considered more profitable, making them more attractive to investors.

Dividends and Shareholder Returns
EPS is used to determine the dividends a company can afford to pay out to its shareholders. The higher the EPS, the greater the potential for rewarding shareholders through dividends or stock buybacks.

Market Sentiment Indicator
Changes in EPS, especially quarterly or annual growth, can significantly impact market sentiment. A company that reports a higher-than-expected EPS may experience a surge in its stock price due to positive investor sentiment.

Interpreting EPS can sometimes be straightforward, but there are nuances to consider. A high EPS can be a good indicator of profitability and, in turn, more attractive to investors. However other factors such as the P/E ratio, industry comparisons, and growth potential should also be analyzed. Conversely, a lower EPS might signal trouble, such as declining profitability or increasing costs.

Increasing EPS
A steady increase in EPS indicates that a company is growing its earnings effectively and is often seen as a sign of long-term stability. Investors tend to favor companies with consistent earnings growth.

Declining EPS
A decline in EPS over time can signal that a company is facing profitability issues, increasing competition, or market challenges. A company with declining EPS may experience lower stock prices if investors lose confidence.

EPS Growth vs. Price Growth
Even if a company shows an increase in EPS, it’s essential to compare that growth with stock price growth. If the price has risen too quickly, the stock may still be overvalued, despite an increase in EPS.

Comparing with Industry Peers
When analyzing a company’s EPS, it is crucial to compare it to others in the same sector. A company with a high EPS compared to its peers is typically viewed more favorably by investors.

Quality of Earnings
Not all earnings are equal. If a company’s increase in EPS is due to one-time events, such as asset sales or tax benefits, it might not be sustainable. Look for sustainable growth driven by core business operations.

It’s important to remember that EPS figures can’t really be compared across companies. There’s no such thing as a “good” earnings per share. What is considered a “good” EPS can vary significantly depending on the company, its industry, and the broader market conditions.

The core reason is that share counts can be extraordinarily different. A company that earns $3 per share, and has 1 billion shares outstanding, generates far more profit ($3 billion) than a company that earns $30 per share and has only 1 million shares outstanding ($30 million). 

But the context of EPS also matters. $3 per share in EPS would be impressive if the company earned only $1 per share the year before. It’s far less so if the company earned $4 in the prior period. 

Similarly, the share price matters. A stock with a price of $30 and $3 in EPS has a much lower price-to-earnings ratio than does a stock with a price of $300 and the same $3 in EPS. Just as a share price on its own doesn’t make a stock price ‘cheap’ or ‘expensive’, earnings per share on its own doesn’t prove fundamental value.

That said, context is key:

• High EPS in a Growth Industry: A high EPS can indicate a market leader in a growth industry, such as technology or healthcare.
• Stable EPS in a Mature Industry: A consistent, moderate EPS is often considered positive in more stable industries, like utilities, where growth is slower.
• Comparison to Peers: A good EPS is also one that is higher than the industry average, suggesting that the company is outperforming its competitors.

As noted in the discussion surrounding anti-dilutive shares, a company can post a net loss, or negative net profit. In that case, its EPS will be negative as well.

What does a negative EPS mean? Once again, it depends on the context. A company relatively early in its growth curve could post negative earnings per share since it is investing now for future growth. A more mature company could simply have a bad year operationally (as many companies did during the novel coronavirus pandemic). An accounting charge related to a past acquisition (often referred to as a ‘writedown’) could erase profits and lead to a reported net loss. A large, one-time, litigation settlement can lead to a short-term spike in expenses.

Negative EPS typically isn’t good news — but on its own, it doesn’t necessarily mean a stock is uninvestable, or even too expensive. A company with negative earnings per share is not necessarily a company with little or no value. Why the EPS is negative usually is more important than by how much it’s negative.

EPS is just one of the common fundamental metrics. Book value is another — but the two metrics are very different.

Earnings per share focuses on profitability. Book value per share, in turn, concerns assets and debt. Earnings per share shows up on the profit and loss statement; book value (also known as shareholders’ equity) on the balance sheet.

Both metrics can be used to understand the fair value of a stock — but from very different perspectives. To oversimplify somewhat, book value per share is a calculation of a company’s assets per outstanding share. EPS shows what profit per share the company can generate with those assets. 

While EPS is an essential metric, it does have some limitations. Here are five common drawbacks to keep in mind:

Does Not Account for Debt
EPS does not directly account for the company’s debt levels. A company with high debt may have a high EPS due to lower interest expenses, but this could be a risk in the long run.

Can Be Manipulated
Management may sometimes use accounting tactics to inflate earnings, such as by deferring expenses or recognizing revenue early. This can lead to an inflated EPS figure that does not reflect the true financial health of the company.

Ignores Non-Recurring Costs
EPS does not exclude one-time charges, such as restructuring costs or write-offs, which can distort the actual profitability of the company. It’s important to look at adjusted or core EPS to exclude these factors.

Does Not Account for Cash Flow
EPS focuses on accounting profits but does not consider cash flow, which is essential for evaluating a company’s ability to meet its obligations, invest in growth, and pay dividends.

Does Not Reflect Market Conditions
EPS is a company-specific metric and doesn’t always account for broader market conditions or economic factors that can impact a company’s performance. A strong EPS in a declining market could still be a sign of vulnerability.

InvestingPro offers detailed insights into companies’ Basic and Diluted Earnings Per Share (EPS) including sector benchmarks and competitor analysis.

Basic EPS calculates earnings based on the number of shares currently outstanding, while diluted EPS accounts for all potential shares that could be created through stock options, convertible securities, etc.

A higher EPS often results in an increase in stock price, as it reflects stronger profitability, making the company more attractive to investors.

A negative EPS means the company has incurred a net loss. It suggests that the company is unprofitable and could be facing financial difficulties.

EPS is typically reported on a quarterly and annual basis. Quarterly EPS reports provide a snapshot of short-term profitability, while annual EPS reflects long-term performance.

Yes, a company with low or negative EPS may still be a good investment if it has high growth potential, strong management, or is in a turnaround phase.