What Earnings Per Share (EPS) Tells Investors

Earnings per share, or EPS, puts a company’s earnings in the context of its common stock. Investors can examine that figure from one reporting period to another or use it when researching businesses with similar operations. However, while this metric can provide useful information about an investment, assessing a company more fully requires other financial results.

A financial advisor can help you evaluate how individual stocks fit within your broader investment strategy.

What Is Earnings Per Share (EPS)?

EPS relates a company’s earnings to its common stock without describing the business solely by its total profit. A result above zero indicates that earnings were available to common shareholders for the period. Meanwhile, a figure below zero can result when the company reports a loss.

The figure gains context when examined across multiple reporting periods. You can review quarterly or annual results to see how the amount has moved. You might also look at businesses operating in the same industry for another point of comparison. Profit levels and typical valuations can vary widely from one sector to another.

Investors can also incorporate EPS into stock valuation. Dividing a company’s share price by EPS produces its P/E ratio, which investors can compare across periods or with similar businesses. Context matters, as companies with different growth prospects, financial risks and business characteristics can command very different valuations.

Analysts may also look at normalized EPS. This modifies reported earnings to remove certain items viewed as outside the company’s regular business performance. Since the adjustments are not necessarily identical from one business to another, investors will want to note which items the company removed before comparing figures.

How to Calculate EPS

Basic EPS uses the profit attributable to common stock for the period alongside a share figure that reflects changes in the company’s common stock during that time.

For example, assume Company A reports $2 million of net income and $275,000 of preferred dividends. It has 12 million weighted-average common shares outstanding during the period. Its basic EPS would be about $0.14.

($2,000,000 – $275,000) ÷ 12,000,000 = $0.14

Companies may also report diluted EPS, which considers how certain financial instruments could change the number of shares reflected in the result. Stock options, restricted stock units and certain other instruments can affect this calculation. When those securities reduce the amount of earnings represented by each share, diluted EPS will be below basic EPS.

Suppose Company A’s applicable dilutive securities add the equivalent of 2 million shares to the simplified calculation, bringing the total from 12 million to 14 million. Using the same $1.725 million of earnings produces a result of approximately $0.12 per share. The difference between the two figures shows how potential dilution changes the per-share result.

Why Is Earnings Per Share Important?

EPS can reveal changes in the earnings represented by each share, but the reason for those changes requires a closer look. An increase could come from greater net income, fewer shares in the calculation or both. A decrease could reflect weaker profits or an expanding share count.

Stock prices do not necessarily move in the same direction as EPS. Investors should consider what a company reports relative to what the market had anticipated, along with revenue, margins, cash generation, forecasts and economic conditions. Shares can decline after EPS rises when the results disappoint investors, while a company with weaker earnings can still see its stock advance when expectations had been lower.

The dot-com era illustrates why investors should not separate profitability from valuation. During this era, many technology companies attracted high valuations based largely on expectations for future growth. When some businesses failed to produce financial results that supported those expectations, their share prices fell sharply. EPS is one measure investors can use to compare the earnings a company is actually producing with the valuation the market has assigned to its stock.

Earnings Per Share and Dividends

EPS describes earnings associated with common shares, whereas dividends are payments authorized for shareholders. A company can report a profit without paying a dividend, and earning more does not require the board to increase distributions.

Profits kept inside the business may go towards expansion, acquisitions, debt repayment, capital expenditures or share repurchases. Dividend-paying companies can also retain some of their earnings. Investors interested in income can examine dividends per share relative to EPS to see what portion of earnings a company is paying to shareholders.

For example, a company earning $4 per share and paying $1 in annual dividends has a 25% dividend payout ratio in this simplified calculation. That means the company distributes one-quarter of its earnings per share through dividends, while retaining the remaining amount.

Evaluating EPS During Earning Seasons

Public companies provide financial reports throughout the year, giving investors regular opportunities to review their results. For U.S. businesses subject to SEC reporting requirements, quarterly filings generally appear on Form 10-Q, while Form 10-K provides the annual report. These filings include per-share earnings information when applicable.

Market participants commonly measure reported EPS against analyst forecasts and the company’s prior performance. A result that comes in above or below the prevailing forecast creates what the market generally refers to as an earnings surprise.

The direction of the surprise alone does not determine how the stock will perform afterward. The market may have anticipated part of the result before the report was released, while revenue, margins, future guidance or management’s outlook may attract more attention than the EPS figure itself.

How to Use EPS Before Buying a Stock

To effectively use EPS, rather than relying on the latest quarter, examine how EPS has moved across a longer period. Then, look separately at total net income and changes in the company’s share count. This can help distinguish improvement driven by greater profits from an increase caused by fewer shares being used in the calculation.

For example, suppose a company’s net income remains at $1 billion while its weighted-average share count falls from 500 million to 450 million. EPS would increase from $2 to about $2.22 even though total profit did not grow. The higher EPS resulted from fewer shares dividing the same amount of earnings.

Measure	Earlier Period	Later Period
Net income	$1 billion	$1 billion
Weighted-average shares	500 million	450 million
EPS	$2.00	$2.22

It’s also worth reviewing basic and diluted EPS side by side. A difference between the two can indicate that instruments capable of increasing the share count are having an effect on the diluted figure. Investors can use the company’s financial statement notes to see what contributed to that difference.

After reviewing EPS, examine the company’s revenue, cash generation and debt position. An increase in per-share earnings that accompanies improving business results has different implications from one produced primarily by a shrinking share count. Looking at those figures together can provide more information about the source of the change.

Price is another part of the decision. You can examine the company’s valuation relative to its own past levels and comparable businesses while considering differences in expected growth and financial risk. A strong EPS figure alone does not establish whether the current stock price offers an attractive investment opportunity.

Bottom Line

EPS provides one way to examine a company’s earnings in relation to its common shares. Investors can look at what caused the figure to move, how it compares with prior periods and whether the business’s other financial results support the same picture. Before purchasing a stock, reviewing revenue, cash flow, debt and valuation alongside EPS can provide additional context.

Tips for Investors

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