Definition
Earnings per share is the monetary value of earnings per outstanding share of common stock for a company.
Earnings Per Share – EPS
Earnings Per Share or EPS is an important financial ratio. It is an important statistic as it shows the efficiency of an organization to use its available assets to generate profits for the shareholders. It is calculated by dividing the total earnings by the total number of outstanding shares of a company. This ratio is calculated over the common stock values.
The Financial Accounting Standards Board or FASB in the United States describes that EPS needs to be calculated when presenting an income statement. It needs to cover four different categories in this regard. EPS information should be calculated on the net income, continuing operations, discontinued services and on extraordinary items.
Preferred stocks are generally not included in the EPS calculations. The dividends given on these stocks are usually subtracted from the total income as they are special purpose cumulative stocks.
The common formula used to find EPS is:
EPS=(Profit-Dividend on Preferred Shares)/(Average Common Shares)
Diluted EPS
Diluted EPS is often calculated if the company has the ability to convert outstanding shares into other financial forms, such as bonds and securities. It is designed to provide a calculation for the worst case scenario where a company has to pay all its bonds and securities within the next fiscal year from its income. The EPS values are adjusted for the number of shares that are in a diluted state which results in an overall decreased value.
Both the income and the number of outstanding shares are changed when calculating Diluted EPS. It is becoming more popular and many companies currently use this system which specially has policies such as convertible stocks, share buying options and employee stock purchase plans.
EPS Gives Stock Value
When investors are looking at different companies and evaluating them for future investments, they give a lot of importance to EPS values. Although a company may represent its EPS information by buying back its own shares, but a look at a few diluted EPS values is enough to find out if the company is good enough for making an investment.
It is important to note that EPS values can also be industry specific and different companies should therefore, only be researched according to their market trends. A company presenting unique figures that are different from the current EPS industry trends may, in fact, represent an organization with bad financial practices.
Further Reading
- Economic value added, future accounting earnings, and financial analysts' earnings per share forecasts – link.springer.com [PDF]
- Corporate forecasts of earnings per share and stock price behavior: Empirical test – www.jstor.org [PDF]
- Earnings management through transaction structuring: Contingent convertible debt and diluted earnings per share – onlinelibrary.wiley.com [PDF]
- On the predictability of corporate earnings per share behavior – www.jstor.org [PDF]
- Combining forecasts to improve earnings per share prediction: an examination of electric utilities – www.sciencedirect.com [PDF]
- Stock repurchases and executive compensation contract design: The role of earnings per share performance conditions – meridian.allenpress.com [PDF]
- Discussion of earnings management through transaction structuring: Contingent convertible debt and diluted earnings per share – www.jstor.org [PDF]
- A Comparative Study of the Forecasting Accuracy of Holt‐Winters and Economic Indicator Models of Earnings Per Share For Financial Decision Making – www.emerald.com [PDF]
