What Is Earnings Per Share (EPS)?

An infographic that explains what earnings per share (EPS) is, how it is used and what its limitations are

Earnings Per Share or EPS is a financial ratio that describes a company’s profit per every outstanding share of stock. Typically, EPS gets calculated quarterly and annually. The calculation is fairly straightforward. You take a company’s quarterly or annual profits and divide them by the number of outstanding shares in the market.

Outstanding shares are shares of stock that are currently in the possession of stockholders. As opposed to issued shares, which are all shares issued by a company. By dividing the net profits by the outstanding shares, you can gauge whether a company is profitable or not.

Basic Earnings Per Share and Diluted Earnings Per Share

One of the single most important variables for figuring a company’s share price comes from calculating Earnings Per Share. Whenever a company realizes a high EPS, it’s a strong indication that it is profitable and might share its profits with its shareholders.

Basic EPS Example:

If a company issues 1,000 shares and earns $100,000, its earnings per share will be $100/share. Any dividends the company is paying need to be deducted from the net earnings before calculating EPS.

A large determining factor in a company’s price-to-earnings ratio when figuring its valuation also comes from EPS and Diluted EPS calculations.

Diluted earnings per share is another calculation that factors in the value of stock options and convertible bonds. Since stock options or convertible bonds could result in more stock being issued, the diluted EPS calculation is a great way to plan for various hypothetical situations. Various accounting standards are used, and these standards can change from company to company.

Why EPS Matters to Investors

A company’s earnings per share is a great indication of its profitability and is a great way to determine if it is worth investing in.

EPS, on its surface, may not have much value to its shareholders. This is because most investors typically don’t have access to a company’s earnings. However, by comparing the company’s EPS with its current stock price value, investors can get an idea about its profits. In addition, by reviewing a company’s EPS history, one can estimate a company’s future growth over time.

Distorted EPS Calculations and Extraordinary Items

Several factors can cause a company’s Earnings Per Share to be distorted. Sometimes this distortion is intentional, and sometimes it’s unintentional. In addition, EPS can often be inflated, so investors and economists will often use variations to account for many inflation factors.

Let’s take a look at a fictional company to understand these terms better:

A manufacturing company that makes medical products has been on the same land for decades. Recently, this land has become highly valuable. It is so valuable now because of the mature forestry that was in its infancy decades back when the company was first started.

The company decides to allow a lumber producer to come in and harvest the surrounding forestry. They make a generous profit from the sale of their trees. And now, with empty land, they can sell blocks of it to other developers. The sale of the forestry and parcels of their land has been nothing short of a huge windfall for the medical manufacturing company.

This land and lumber sale generated substantial profits for stockholders. However, it is considered an extraordinary item because it cannot be generated regularly as it was a one-time deal.

If the fictional company above included this windfall in their EPS calculations, their shareholders will have been misled. This is why the option of listing certain revenues as extraordinary items exists.

Alternatively, if the company experiences a tremendous loss, that loss could be excluded from EPS calculations. For example, if the fictional company above suffered a substantial loss from a wildfire on the company’s property, this loss could be excluded from their EPS.

Earnings Per Share Limitations

As with anything in the world of investing and finance, there are some limitations and caveats. First of all, companies do not have to include outstanding debt in their EPS calculations. Should a company decide to settle any debt that they may have, this would dramatically decrease their Earnings Per Share.

A company can also falsely inflate its EPS ratio. They can do this by purchasing back some of their own stock to increase their EPS calculations.

EPS, Dividends, and Capital

As you’ve seen so far, Earnings Per Share is a great way to judge a company’s profitability. However, shareholders don’t always have direct access to a company’s net proceeds. Instead, the company decides if it will pay its shareholders a dividend. Shareholders can only directly access the profit represented by EPS by having their board representative push for internal company bylaws to change.

It’s difficult to properly define the value behind EPS because many shareholders won’t have the benefits of earning dividends or a portion of the revenue defined by their stock’s EPS calculations. In the example of our medical company above, they may have included a clause in their Initial Public Offering (IPO) that specifically stated they will not pay dividends and have no plans to pay dividends in the future. Lack of dividends or profit-sharing makes certain investors wonder why anyone would ever invest in that kind of company.

EPS calculations don’t always correlate with share prices. Two stocks in the same sector could have the same Earnings Per Share ratio, yet both may have drastically different share prices. Think about it, a company with $100MM in net revenue and 1MM outstanding shares will have an EPS of $100. A company with just $100,000 in net revenue and 1,000 outstanding shares also has an EPS of $100. Regardless of the outstanding stocks, it’s not likely that a 9-figure company will trade at the same price as a 6-figure company.

EPS and Continuing Operations

Let’s say a company started its fiscal year with 100 retail locations. Unfortunately, some of these locations were operating at a loss and, as a result, are closed down. Instead, the company ended the year with 75 profitable retail locations.

Calculating EPS based on all 100 stores will result in lower earnings per share than if EPS is calculated for just the 75 profitable stores.

Calculating the EPS for just the 75 profitable stores will result in much higher earnings per share than if all 100 stores were averaged into the calculation.

Retained Earnings Per Share 

Retained EPS is calculated by adding any currently retained revenue to its net income before dividing it by the number of outstanding shares.

This figure shows the profit that the company will hold on to and not distribute as dividends. This figure can only include retained net earnings.

Because of the way retained earnings are calculated, they can also be shown as a loss, called negative retained earnings. To calculate negative retained earnings, you subtract the loss from the company’s net income before dividing it by the total number of outstanding shares. A company might use its retained earnings to expand its operations or pay off a debt. This is why there can be a loss while the company is still showing net earnings in revenue.

By keeping an eye on a company’s retained earnings, you can determine if a company is using its profits wisely. This can help you make better decisions regarding holding, selling, or buying more of your stock.

Price-to-EPS Ratio / Price to Earnings

The share price in relation to the EPS is known as the Price-to-EPS ratio (or Price To Earnings). It is calculated by dividing the share price by the EPS calculation. Whenever EPS is hard to use as a determining factor on its own, the Price-to-EPS ratio will help investors paint a better picture of profitability and future growth. 

Comparing Price To Earnings to stocks in the same industry or sector can be highly beneficial for investors. For example, it may seem that a stock whose share price is high relative to its EPS might seem overvalued compared to stocks in the same industry. However, the inverse to this is true as many successful investors would much rather pay a higher price for a stock that can outgrow other stocks of the same sector.

Earnings Per Share Formulas

Formula for earnings per share
formula for extraordinary items
formula for continuing operations

Additional Reading:

KPMG has a fairly dense but interesting accounting perspective on earnings per share calculation and reporting here.

Columbia law analyzes the role of earnings per share during mergers and acquisitions here.

Vikram R
Vikram Raghavan is a value investor, technologist, and Finexy co-founder. In addition to stock market investing, Vik also invests and advises startups on growth marketing and product management. Vik's work is focused on themes of marketplaces, micro-entrepreneurship, marketing automation, and user growth. Previously, Vikram led product and growth teams at Overstock.com, focusing on efforts across acquisition, new user experience, churn, and notifications/email. He holds an MBA in Finance from Temple University and a B.S. in Computer Information Systems and Finance from Bemidji State University.