After following stocks for a short amount of time you’ll come across the term Earnings Per Share (EPS).
And quotes like “analysts upgrade EPS for company Y” or, “company X has cancelled their guidance for EPS this quarter”. What does all the even mean?
To get to EPS or to be able to calculate it you first need shares outstanding.
Shares outstanding is the definition given to the shares that’re currently held by every shareholder.
For example, say I own two shares of company XYZ and you own 2 shares of company XYZ then there’s 4 shares outstanding.
The premise is the exact same for public corporations except they’re on a much larger scale compared to those 4 shares.
Take Visa, they have around 2,272 billion shares outstanding. This means there’s 2,272 billion shares out there in the world and available for people to buy if someone wanted to sell their shares.
There could be over 10,000 shareholders, each holding a varying amount of shares, or there could be 1 million different shareholders.
There’s no specific amount to the number of shareholders but there’s limited shares available for people to buy. Unless of course the company does a capital raising to issue more shares in exchange for cash.
Earnings Per Share: EPS
EPS is short for Earnings Per Share, okay I get that but what is earnings per share?
EPS represents the profitability of a company on a single share basis (that’s why it’s per share), it’s the profit that’s left over or the net income from a company and spread out across all the shares outstanding.
If you see a company that had EPS of $1.50 that means for every 1 share the company earnt $1.50.
If you’ve read my post on what are shares, you’ll know that owning shares is just like owning a company. When a company is broken up into all its shares outstanding it’s easy to think of each share as tiny portion of the company, and each of those tiny portions is allocated a portion of the profit.
How to calculate EPS
It’s some simple math to calculate EPS, I’ll use Visa as an example
In 2019 Visa had net income or a total profit of $12.08 billion there was also 2,272 billion shares outstanding.
Once you have the information of the net income and the shares outstanding its calculated as:
Net income / shares outstanding
In this case it’ll be:
$12080 / 2272 = $5.31
This means for every 1 share Visa earned $5.31.
Now you know how to calculate EPS you’ll start to come across two different variations of it… As if this isn’t confusing enough.
Basic and Diluted EPS
There is two EPS variations that you can use, you’ll find both of these terms on investment websites and, on a companies financial statements.
The term Basic EPS represents all the shares that are currently out there in circulation which you’ll see what I mean below. For the meaning of diluted, there’re some investors who own other types of securities that can be converted into common stock, and if they were all to convert those securities it would add to the shares outstanding.
Basic EPS Example
If there were 100 shares currently in circulation and 50 are held by me and 50 are held by you, then those 100 shares will be used in the calculation for Basic EPS.
Diluted EPS example
This is where it gets a little confusing but don’t worry it starts to make sense. Using those same 100 shares on issue, but now I have another 25 securities that aren’t outstanding but I could convert them to create 125 total shares outstanding (my 50 shares plus another 25 and your 50 shares)
Diluted EPS takes into account all the shares that could potentially be exercised. (And dilute the current shareholders by adding more shares to the pool)
Some companies will have issued stock options, warrants, convertible preferred shares etc. Diluted EPS is using the same net income and then assuming all those stock options, warrants & convertible preferred shares have been converted into common stock.
Basic EPS will usually give you a higher number then diluted because there’s less shares to spread the profit around.
Which one should you use?
It’s completely up to you which EPS you want to use, more conservative investors will use Diluted EPS because that’s taking into account all the potential shareholders. Other investors might think it’s a low probability for that to happen so they might just use Basic EPS.
Why investors use EPS
Everything in the stock market is based off a per share basis because again, owning 1 share is like owning an entire company. You want to know what you’re getting for each share of your ownership.
Investors also know there’s a strong correlation between rising share prices and company earnings. If EPS is rising then usually the share price is rising. If EPS starts declining then usually the share price will decline.
Below is a price chart of Visa since 2009, I have attached the Diluted EPS so you can see as the earnings slowly climbed the share price also climbed. There was periods of flat or reduced earnings but overall it’s going up.
Then there’s Telstra, what use to be one of the darlings of the Australian stock market. Earnings started declining, and look what went with it… the stock price!
Wrapping it up
You now know what EPS is and how to calculate it, and that the share price is correlated to EPS performance. A word of caution though. Don’t just go out and buy companies if their earnings are rising. That’s not what I’m saying for you to do, this was just a explanation to show you what EPS is. You will need to do more research before buying any company, using EPS alone isn’t enough.
Leave a comment below if you have any questions, I’m always happy to help!