Before you invest in a company, you want to be sure it’s profitable. A way to do this is by calculating a company’s earnings per share. Earnings per share is a widely used metric that tells you how much profit a company makes on per share of its stock.
Companies report their EPS on their income statement, which can be an annual (10-K) or quarterly (10-Q) SEC filing. If you’re a prospective investor or trying to deep-dive into your learning, here is everything you should know.
Types of EPS
There are two types of earnings per share; basic earnings per share and diluted earnings per share. Basic earnings per share is a company’s earnings relative to each common outstanding share. Diluted earnings per share is similar, but it adjusts for dilutive securities before looking at the company’s earnings compared to each common outstanding share.
Diluted earnings per share are typically used when doing a deep analysis and are seen as a more accurate reflection of a company’s financial health. This is because it takes into account dilutions, which are when a company issues new shares and a shareholder’s ownership percentage of the company decreases as a result. An example is when a business distributes employee stock.
As a rule of thumb, sometimes basic EPS is better suited for smaller companies, assuming they have few or no diluters. On the other hand, diluted EPS can be better for larger companies as they’re likely to have potential diluters. That said, basic EPS is simpler and can give you a general idea of how a company is doing.
Calculating Earnings Per Share
To calculate earnings per share, you divide a company’s net profit in one quarter or year by their outstanding stock. In the event the company has preferred dividends to pay out, you would deduct that from the earnings.
Earnings per share = net profit/available stock
Or
Earnings per share = net profit – preferred dividends/available stock
For example, if a company has an annual net profit of $200 million and 15 million available shares, the earnings per share is $13.3.
Using EPS To Make Investing Decisions
The higher a company’s EPS, the better they performed during their earning period. As you can guess, people are willing to pay more money to invest in a company that’s perceived to be performing well, making it more valuable. For most investors, a valuable company is a green light.
That said, if you find a company’s EPS is low, that doesn’t mean you should steer clear. It does, however, mean you should do more research before investing there could still be potential for growth. For instance, if you look at the company’s EPS over several quarters you may find they’ve had one low quarter and the majority of others have been higher. You may also want to compare the company’s EPS with others within the same industry.
Considering every investment carries risk, consider speaking to a financial planner on our team if you need more advice about which companies are profitable and which to invest in.
Why EPS is Important
Having knowledge of a company’s earnings per share is important because their EPS can impact their stock price. This is why it’s not unusual to see a company’s stock price go up when they do well in a quarter. Likewise, when earnings fall in a quarter it could indicate that their stock prices are going to decrease.
In conclusion EPS is one of many ways to gauge how healthy a company is before you invest your dollars. As with any investment, it’s important to remember nothing is absolute and there is risk involved.
