What is Earnings Per Share (EPS) and Why Should You Care?
Earnings Per Share (EPS) is a financial ratio that measures the amount of profit allocated to each outstanding share of common stock. Think of EPS as a way to figure out how much money each share of stock earned over a specific period, like a fiscal quarter or year.
Why should you care? Well, for investors, EPS is a key indicator of a company's profitability and financial health. A higher EPS often signifies a more profitable company, which can make the stock more attractive to potential investors. In simple terms, it gives you a quick snapshot of how well the company is doing in making money for its shareholders.
How to Calculate Earnings Per Share
Calculating EPS isn't rocket science; you just need to know a few key components:
- Net Profit: This is the total profit of the company after all expenses have been deducted from total revenue.
- Dividends of Preferred Stock: These are dividends that need to be paid out to preferred shareholders and are subtracted because they aren't available to common shareholders.
- Outstanding Common Shares: This is the current or average number of shares held by all shareholders.
Here's the formula to calculate EPS:
[\text{EPS} = \frac{\text{Net Profit} - \text{Dividends of Preferred Stock}}{\text{Outstanding Common Shares}}]
Where:
- Net Profit is the total profit of the company (after all expenses).
- Dividends of Preferred Stock are the total dividends distributed to preferred shareholders.
- Outstanding Common Shares is the number of shares currently held by common stockholders.
Calculation Example
Let's bring this to life with an example. The more examples, the better your understanding!
First, let's determine the net income. For this example, let's assume the company's total profit is $2,000,000.
Next, we need to calculate dividends on preferred stock. Suppose this is 3% of the total profit, equating to $60,000.
Finally, consider the total number of outstanding common shares. Let's say we have 100,000 shares.
Plugging these numbers into our formula:
[\text{EPS} = \frac{2{,}000{,}000 - 60{,}000}{100{,}000}]
[\text{EPS} = \frac{1{,}940{,}000}{100{,}000}]
[\text{EPS} = 19.40]
And there you have it - an EPS of $19.40. This tells you that each share of common stock earned $19.40 in profit.
So, why care? Because if you're making investment decisions, a higher EPS often means a healthier, more profitable company, which could signify better returns on your investment.