Earnings Per Share EPS: Is High EPS Always a Good Investment?

Earnings Per Share (EPS): Formulas, Examples, Good and Bad EPS

Profitability is one of such factors when investing in shares. An investor would only want to benefit from buying stock in a company by making income out of it. Therefore, a company without profit makes no investment sense. Hence, EPS or earnings per share becomes a good indicator that explains how profitable a firm is.

It led to investors and organizations claiming it is the best yardstick to measure financial results over the years. Earnings Per Share is a criterion that investors employ when comparing firms and picking those that will yield higher profits. Also, they ensure that those who might bring a considerable amount of money are identified. This blog focuses on EPS in stock markets and why it is an indicator in financial analysis.

           Earnings per share formula: a crucial metric for investors. Learn about EPS benefits and key facts.

Key Highlights

  • Earnings per share, abbreviated as EPS, is often used as one measure of corporate valuation.

  • Since there is a high EPS, it is valued highly, and investors are willing to acquire much stock as they perceive that the company has higher profit margins than its stock prices.

  • There are various ways of getting at EPS, including omitting extraordinary expenses, discontinuing operations and operating on a diluted base.

  • Like the other financial metrics, earnings per share is most beneficial compared to competitor metrics, competitors within an industry, and across a particular period.

What Is the Meaning of Earning Per Share (EPS)?

One key indicator of a company's success or profitability is "earnings per share" EPS. It is the computed value of a company's net income divided by the total issued and paid-for share capital. Market participants commonly use this instrument to assess a company's profitability before purchasing its shares.

People usually consider it when making investment decisions in the share market. As an investor, you always see these companies with high EPS stocks as more profitable and worth the investment because they offer a better return on your investments

Therefore, these investors and other analysts use this to compare companies operating in a similar industry/sector. They use EPS to find out which one is earning them the most profits. It can also be utilized to look for EPS stocks with better chances of offering high returns.

It may be combined with other financial metrics, such as the P/E ratio. It is also one of the approaches that can ascertain the value and capacity to develop in corporate aspects. 

This is why, that way, you can determine equal companies within a particular industry for comparison. You could also pinpoint prospective investment areas. Moreover, it also determines share prices, so an added corporate value ensues.

The Formula for Earnings Per Share

The formula for calculating earnings per share (EPS) is:

EPS = Net Income – Preferred Stock Dividend/ AOS.

For example, if a company has a net income of $10 million, preferred stock dividends of $1 million, and an average of 5 million outstanding shares, the EPS would be:

EPS = ($10 million - $1 million) / 5 million

EPS = $1.80

How Do Earnings Per Share EPS Work?

  • EPS is like a pizza that's cut into slices. The bigger the pizza (company's net income), the more slices there are to share.

  • EPS tells you how much of the pizza each shareholder gets to eat. A higher EPS means each slice is bigger and more valuable.

  • Per-share EPS measures a company's profitability, like estimating your hourly wage, but for corporations.

  • Investors and analysts compare EPS to other industry businesses to evaluate a company's financial performance.

  • Higher EPS signifies better profitability, which may entice investors and boost stock demand.

  • EPS shows a firm's profit per share of its common stock, helping investors make better acquisition or sale choices.

Read Also: Berkshire Hathaway's Massive Market Cap and Net Worth (Detailed)

How Does EPS Affect a Stock's Price?

EPS may significantly affect stock prices. 

Companies with higher Earnings Per Share are usually more profitable and have more profit potential. High EPS may attract additional investors, raising stock demand and price. 

Conversely, a company's EPS decline or failure to reach market expectations might lower stock demand and price.

When assessing a company's stock, investors typically consider EPS. 

A greater EPS usually means the stock is more valuable. Consequently, it can cost investors more money. The price-to-earnings ratio (P/E ratio), essential for EPS, is another tool investors use to evaluate a company.

EPS shouldn't be the main factor when assessing a stock. Revenue growth, industry trends, and financial health should also be considered.

What Are the Limitations of EPS?

EPS is a standard stock market financial indicator, although it has flaws. This section covers three significant drawbacks.

  • Can be Manipulated: Companies can manipulate their earnings to reach a particular EPS level as well. They may manipulate sales figures through accounting adjustments, over-recording revenue, or delaying expenses. Hence, it is appropriate for investors and analysts to take note of EPS.

  • Doesn't Consider Inflation: Current earnings serve as our basis for calculating Earnings per Share, and they ignore the effects of inflation. Basically, income per share is usually deceiving as it does not consider the inflation factor and its impact on companies.

  • Does Not Reflect the Quality of Earnings: EPS do not inform readers on the quality of earnings, like whether they are core or will stay in the future.

What is Diluted EPS?

The concept of Diluted EPS or earnings per share considers the possible influence resulting from a firm's dilutable securities. Dilutive securities refer to things like stock options, convertible bonds, warrants, etc., which are capable of additional dilution of an existing number of outstanding issues in future.

This is done by adjusting the earnings and outstanding shares as if those diluted securities had been converted or exercised. This estimation assumes conversion or exercise of all dilutive securities, and therefore, it is more conservative than the average earnings per share calculation.

Diluted EPS matters as it offers investors an actual view of expected earnings in consideration of such securities issuance. This enables investors and analysts to gauge how much earnings will be affected if all dilutive securities are converted or exercised.

Diluted EPS Formula

= Net Income / (Total Outstanding Shares + Potential Dilutive Securities)

=  $7.69 per share, being an average of $100,000/ (10,000 + 2,000).

Here, the company's basic EPS equates to 10 rupees, and its diluted EPS stands at 7.69. This means that Diluted EPS is lower than the basic EPS because the securities may be considered to weaken in this case.

What is Adjusted EPS?

Adjusted EPS, a non-GAAP indicator, lets organizations modify their earnings to account for one-time or extraordinary occurrences that may have affected profitability. These adjustments remove extraordinary or non-recurring elements to show a company's continuous profit potential. 

Adjustments may include restructuring charges, asset impairments, and asset sales gains/losses. Adjusted EPS gives investors and analysts a more realistic picture of a company's earnings power. It allows for better comparability between companies and helps to eliminate distortions caused by extraordinary events.

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What Is a Good EPS Ratio?

A good EPS ratio depends on the industry and the company's size. There is no uniform answer for measuring a good EPS ratio. In a nutshell, higher EPS denotes more profits, which is usually seen as a positive thing for investors. 

One should consider other measures like income growth, economic climate, market environment, and overall business stability while assessing corporate success.

Example: A tech firm can have better earnings per share (EPS) than a manufacturing firm, depending on their operations. Likewise, a big company can exhibit a lower EPS ratio than a small one, provided that they differ in terms of capital structures applied.

Is a High EPS Good or Bad?

A high EPS is generally considered good when evaluating a company's financial performance. A high EPS implies that a firm is more profitable and promising in terms of future earnings. 

More people wanting to buy the shares will prompt more investors to invest, which means a surge in demand, and eventually, the stock's price will rise. 

One should also consider other components like revenue growth, industry trends, and the general financial condition of the firm before determining its results. As such, a high EPS cannot make a company successful or indicate its value.

How a 'good' or acceptable EPS ratio is determined depends upon aspects like average industry standards or a general company's scale. Comparing a company's EPS against its track record and other firms within the specific sector will enable one to appreciate how the firm performs comparatively.

Are Earnings Per Share the Same as Dividends?

Dividends are different from earnings per share. Earnings per share (EPS) is a vital financial indicator assessing an enterprise's profitability per unit share.

This ratio is calculated as a company's net income divided by the average number of shares. EPS enables one to identify the profit a firm generates for every individual unit or a single share of its common equity.

Shareholders get dividends from a company's earnings. While EPS measures profitability, dividends allow corporations to share profits with shareholders. High EPS companies may not pay dividends, whereas low EPS companies may.

Final Words

"Earnings per share" (EPS) is how investors define common stock profit per share. Investors should hunt for stocks with high EPS but also consider other firm-specific characteristics. Earnings per share drive a company's fortunes. 

You should also compare it to other significant financial metrics. EPS helps investors and analysts assess a company's profitability. Knowing a company's profit per share of common stock helps investors choose. EPS should be considered alongside revenue growth, industry trends, and financial health. 

FAQs

What is Earnings per Share?

Analysts and shareholders use various measures to evaluate a firm's profits by examining the EPS. It shows how much percentage of a firm's profits goes into every existing common stock share it has.

How is EPS calculated?

The net income of a business minus any preferred stock dividends, divided by the average shares outstanding over a specific time, gives an EPS. The formula is EPS = (net income – preferred stock dividends)/average outstanding shares.

Why is EPS important?

EPS is crucial because it provides information about how much revenue is gained by one unit or share of the company's common stock. Analysts, investors, etc., consider a firm's earnings per share when comparing rival firms within an industrial zone.

What does a high EPS indicate?

A high earning per share (EPS) often suggests higher profitability in a company and its ability to earn more profits. This may attract more investors, increasing the demand for the said stocks and consequently increasing the stock prices.

Are there any limitations to using EPS?

Eps may have several limitations that include. For instance, EPS needs to be more aware of the quality of profit and risk involved in a firm's proposal. Reducing the number of outstanding shares leads to improved earnings per share (EPS) without improving the firm's overall financial performance. Consequently, in evaluating what constitutes a successful company, one should consider industry trends towards revenue growth, economic health and more.

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22 Jan, 2024

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