What is Earnings Per Share (EPS)?
Earnings Per Share (EPS) is a financial metric that is calculated by dividing the the Net income by the total number of common outstanding shares. Investors use EPS to assess a company’s performance and profitability prior to investing. Higher EPS means the company is more profitable.
Earnings Per share Formula
You can calculate EPS using the formula given below –
Earnings Per Share Formula = (Net Income – Preferred Dividends)/Weighted Average Number of Shares Outstanding
The current year’s preferred dividends are subtracted from net income because EPS refers to earnings available to the common shareholder. Common stock dividends are not subtracted from net income.
Since the number of common shares outstanding may change over the year, the weighted average is used to calculate EPS. The weighted average number of common shares is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Analysts need to find the equivalent number of whole shares outstanding for the year.
Three steps to calculate the weighted average number of common shares outstanding:
Identify the beginning balance of common shares and changes in the common shares during the year.
For each change in the common shares:
- Step 1 – Compute the number of shares outstanding after each change in the common shares. The issuance of new shares increases the number of shares outstanding. The repurchase of shares reduces the number of shares outstanding.
- Step 2 – Weight the shares outstanding by the portion of the year between this change and next change: weight = days outstandingDays OutstandingDays sales outstanding portrays the company's efficiency to recover its credit sales bills from the debtors. The number of days debtors took to make the payment is computed by multiplying the fraction of accounts receivables to net credit sales with 365 days. / 365 = months outstanding / 12
- Step 3 – Sum up to compute the weighted average numberWeighted Average NumberWeighted Average Shares Outstanding is a calculation used to estimate the variations in a Company’s outstanding shares during a given period. It is determined by multiplying the outstanding number of shares (consider issuance & buybacks) in a given reporting period with their individual time-weighted portions. of common shares outstanding.
Earnings Per Share Calculation Examples
Let’s take a practical example to illustrate the earnings per share formula.
Hit Technology Inc. has the following information –
- The net income for the year-end 2017 – $450,000
- The preferred dividends paid in 2017 – $30,000
- At the beginning of the year 2017, the common shares outstanding were 50,000 shares. In the middle of the year, Hit Technology Inc. issued another 40,000 common shares.
Find out the earnings per share of Hit Technology Inc.
In the example, we know the net income and the preferred dividends. That means we know all the information needed for the numerator. However, we don’t know the weighted average of common shares outstanding; because we need to calculate that from the data given.
Let’s calculate the weighted average number of common shares outstanding first.
It’s said that at the beginning of the year, the firm had 50,000 common shares. And in the middle, 40,000 new common shares were issuedShares Were IssuedShares Issued refers to the number of shares distributed by a company to its shareholders, who range from the general public and insiders to institutional investors. They are recorded as owner's equity on the Company's balance sheet.. It means we can consider 50,000 shares for the entire year and 40,000 shares for the last 6 months.
Here’s the calculation –
- Weighted average number of common shares = (50,000 * 1) + (40,000 * 0.5) = 50,000 + 20,000 = 70,000 shares.
Now, we will find out the EPS formula –
- EPS formula = (Net Income – Preferred Dividends) / Weighted Average Number of Common Shares
- Or. EPS formula = ($450,000 – $30,000) / 70,000
- Or, EPS = $420,000 / 70,000 = $6 per share.
Let us take the example of Colgate from the above example, the Net Income (2013) attributable to Common Shareholders is $2,241 million, and common shares outstanding is 930.8 million. EPS calculation of Colgate for 2014 is $2,241 / 930.8 = $2.41
source – Colgate 10K filings
Albatross Inc 2007 Net Income – $1,000,000. Additional data provided below
- 100,000 Class A sharesClass A SharesClass A shares represent the common stocks category, which provides the shareholders with superior rights to voting, conversion, ownership, dividend, and liquidation. These shares cannot be publicly traded in the open market and are generally allotted to the company's top management. preferred cumulative shares, dividend amount of $2.00/share
- 50,000 Class B shares preferred noncumulative shares, dividend amount $1.50/share
- No Dividend declared or paid in the current year
What will be the numerator of basic EPS for Albatross Inc?
The numerator of EPS = Net Income – Preferred Dividends
The weighted average number of shares calculation
Effect of Stock Dividends & Stock Splits on EPS
In calculating the weighted average number of shares, stock dividends, and stock splits are only changed in the units of measurement, not changes in the ownership of earnings. A stock dividend or split shareholders).
When a stock dividend or split occurs, the computation of the weighted average number of shares requires the restatement of the shares outstanding before the stock dividend or split. It is not weighted by the portion of the year after the stock dividend or split occurred.
Specifically, before starting the three steps of computing the weighted average, the following numbers are restated to reflect the effects of the stock dividend/split:
The beginning balance of shares outstanding;
- All share issuance or purchase prior to the stock dividend or split;
- No restatement is made for shares issued or purchased after the date of the stock dividend or split.
If a stock dividend or split occurs after the end of the year, but before the financial statements are issued, the weighted average number of shares outstanding for the year (and any other years presented in the comparative form) must be restated.
Calculate the weighted average number of shares for the following –
The weighted average number of shares is calculated as per below –
Colgate’s Stock Dividends and Earnings Per Share
As a result of 2013, Stock SplitStock SplitStock split, also known as share split, is the process by which companies divide their existing outstanding shares into multiple shares, such as 3 shares for every 1 owned, 2 shares for every 1 held, and so on. The company's market capitalization remains unchanged during a stock split because, while the number of shares grows, the price per share decreases correspondingly. all historical per share data and numbers of shares outstanding were retroactively adjusted. In 2012, the shares outstanding were 476.1 million, and they almost doubled up to 930.8 million due to the two-for-one stock split.
source – Colgate 10K filings
Simple vs. Complex Capital Structure
A company’s capital structure is simple if it consists of only common stock or includes no potential common stock that, upon conversion or exercise, could result in a higher number of shares. Companies with simple capital structures only need to report basic EPS formulaBasic EPS FormulaBasic EPS represents the income of the company for each common stock. In other words, it is the value appreciation of the common shares resulting from equal distribution of the company's profit as dividends among the common stockholders..
A complex capital structure has securities that could have a dilutive effect on earnings per common share.
Let us look at the Colgate earnings per share. We note that there are two variations – Basic and Diluted EPS in Colgate. Also, note that stock options and restricted stock units are affecting the total number of shares outstanding.
Colgate has a complex capital structure – Why? The reason is that their capital structure contains stock optionsStock OptionsStock options are derivative instruments that give the holder the right to buy or sell any stock at a predetermined price regardless of the prevailing market prices. It typically consists of four components: the strike price, the expiry date, the lot size, and the share premium. and restrictive stock units that may increase the number of shares outstanding (denominator). If the number of shares outstanding increases, then the EPS will decrease. Please note in the case of Colgate, the number of shares that increase due to stock options and restricted stock units is 9.1 million for the year 2014.
source – Colgate 10K filings
How Earnings Per Share Affects Stock Valuation?
Earning represents the profitability of the company and is considered to be the most important indicator of the financial health of the company. Earnings are reported four times a year by the publicly listed companies, and we note that research analysts and investors closely follow this earnings season. Growing earnings or EPS is a measure of a company’s great performance and, in a way, a measure of returns for the investor. In fact, EPS is direct to the stock markets by the way wide tracked Wallstreet PE MultiplePE MultipleThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. or Price/EPS ratio. The lower the PE multiple compared to the Industry average PE, the better it is from the point of view of investments and valuations. Stock prices react sharply to quarterly earnings due to the very same connection. For example, below is the share price movement of Blackberry Ltd after the quarterly earnings report. Note the sharp movements in the stock prices. Learn more about Enterprise Value and Equity Value here
source – Reuters
Earnings per Share (EPS) Video
This article has been a guide to What is Earnings Per Share (EPS) and its meaning. Here we discuss how to calculate earnings per share along with with weighted average shares, share splits, and stock dividends along with practical examples. You may also learn more from the following articles on Shares
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