Investors use a number of tools to gauge whether certain stocks are worth investment compared to others on the market. A number of these, including the critical price-to-earnings ratio (P/E), require the calculation of earnings per share, which is also called EPS. Earnings per share illustrates a company's ability to generate profit for shareholders after dividends have been paid. EPS doesn't always mean a lot on its own; it's most often used as a reference to other financial indicators or as a comparison point between multiple companies.
Calculating EPS With Formulas
Earnings per share itself is a straightforward calculation, but there are a couple of variations on what to include when doing the calculation. The basic formula is: EPS = (Net Income - Preferred Dividends) / (Shares Outstanding)
Video of the Day
You can find net income and preferred dividends on a company's financial report. Net income and dividends paid are calculated over a period of time (usually one year), and the number of outstanding shares may change over that period; some analysts choose to use the number of shares that are still outstanding when a certain time period comes to a close, while others will use a weighted average of shares outstanding over the period in question, per the writers at the Corporate Finance Institute.
There are also several ways to modify the EPS equation for more information. "Diluted" EPS includes factors that can affect the total number of outstanding shares, such as options, warrants and convertible securities; this produces an EPS with a theoretical number of shares if these options are activated. "Adjusted" EPS removes minority interest and any profits or losses from non-core activities, producing an EPS that focuses only on core operations.
EPS Growth Rate
EPS growth rate compares earnings per share over a period of time. For example, you could accomplish this by comparing last year's financial report to this year's to look at how EPS has changed. The formula for this calculation is also straightforward: EPS Growth Rate = [ (EPS end of period) - (EPS beginning of period) ] / (EPS beginning of period)
Example: Suppose that a company has $500,000 of net income in 2021. They pay out dividends of $100,000 that year, with total outstanding shares coming in at $1 million (1,000,000). Their EPS for 2021 would then be: EPS = ($500,000 - $100,000) / (1,000,000) = $0.40. This means that each outstanding share has generated 40 cents in income.
If EPS for 2020 was $0.34, EPS growth rate is calculated as: EPS growth rate = ($0.40 - $0.34) / ($0.34) = 0.1764 = 17.64 percent.
Using EPS Growth Rate
If you're using earnings-per-share growth rate as a benchmark to compare two companies, as a general rule, a higher EPS growth rate is preferable to a lower one, says the team at Morningstar Investment Glossary. Some sources recommend stocks with an EPS growth rate over 25 percent to capture companies whose earnings are increasing per outstanding share of stock. Alternately, look at companies with an EPS growth rate that's constant or increasing over the last few years; these are companies focusing on the growth of earnings.
The earnings-per-share value itself is used to calculate the price-per-earnings ratio. The equation for this is P/E = (company's stock price) / (most recent EPS). Comparing the cost of one share on the market to the earnings made per share gives the investor an idea of how high the value of this stock is. A low P/E ratio implies that each share of stock produces more income than it costs, making it more attractive to investors.
Consider also: How to Calculate Diluted EPS