Understanding Earnings Per Share

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Earning per share or EPS is considered one of the primary driving forces behind share market price. EPS is a ratio of the companies past performance per common share.

It is important to compare EPS to like type companies. Depending on the industry acceptable EPS ranges will vary. EPS is most effective when comparing the historical trend of EPS as well as comparing to companies within the same industry and approximate size.

Calculating Earning per Share (EPS)
Earnings per share (EPS) = (Net income after taxes - preferred dividends) / Weighted average of outstanding common stocks
For example, companies X and Y both earn $1000, but company X has 50 shares outstanding, while company Y has 250 shares outstanding. Which company’s stock do you want to own?
It makes more sense to look at earnings per share (EPS) for use as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares.
Using our example above, Company X had earnings of $1000 and 50 shares outstanding, which equals an EPS of 20 ($1000 / 50 = 20). Company Y had earnings of $1000 and 250 shares outstanding, which equals an EPS of 2 ($1000/ 250 = 4).
So, you should go buy Company X with an EPS of 20, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it
THREE TYPES OF EPS NUMBERS
• Trailing EPS – last year’s numbers and the only actual EPS
• Current EPS – this year’s numbers, which are still projections
• Forward EPS – future numbers, which are obviously projections


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What are Diluted Earnings Per Share?

Diluted earnings per share (Diluted EPS) takes the basic earnings per share figure one step further. Basic EPS only takes into account the number of shares outstanding at the time. Diluted EPS, on the other hand, estimates how many shares could theoretically exist after all stock options, warrants, preferred stock and / or convertible bonds have been exercised.

The theory goes that because some or all of these investments could be converted or exercised, the number of shares outstanding could increase at any time. This reduces the amount of a company's earnings each share is entitled to. In doing so, the price to earnings ratio becomes higher, and the stock appears more expensive.

In most cases, the diluted earnings-per-share figure is far more accurate estimation of the total earnings per share and receive special attention when valuing a company.