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There are various financial ratios that investors can use to evaluate a company and its performance. Most of these ratios that focus on the financial performance of a company consider its profits. Out of those, one of the primary ratios that investors can use is the Earnings Per Share (EPS).
What is the Earnings Per Share (EPS) ratio?
The Earnings Per Share (EPS) ratio shows the net earnings that a company has earned per its outstanding shares. It divides the net earnings available to ordinary shareholders by the average outstanding shares over a period of time. The EPS ratio is an indicator of a company’s financial performance and ability to produce earnings for its ordinary shareholders.
Investors can use the EPS ratio to evaluate a company’s earnings potential. On its own, however, the EPS ratio of a company may be futile. Therefore, investors need to use the metric as a comparison tool to evaluate various investment options based on their EPS. Investors must also compare similar companies or those in the same industry to obtain better results.
What is the Earnings Per Share formula?
There are various formulas the investors can use to calculate the EPS of a company. Among these, two of the most commonly used ones are:
EPS = (Earnings Before Interest and Tax – Preferred Dividends) / Outstanding shares at year-end
This formula is straightforward as it allows for easier calculations of the EPS of a company.
EPS = (Earnings Before Interest and Tax – Preferred Dividends) / Weighted Average outstanding shares
The above formula is more complex, as it requires calculating the weighted average outstanding shares. The weighted average outstanding shares is the company’s number of shares calculated by adjusting for changes in its share capital over a reporting period.
Example
A company called “Left Co.” had a net income of $5 million for the last period before adjusting it for interest and tax. The company also announced dividends of $1 million to its preference shareholders. Its total number of outstanding shares at the end of the reporting period was 8 million. Therefore, the Last Co.’s EPS at the end of the reporting period will be as follows.
EPS = (Earnings Before Interest and Tax – Preferred Dividends) / Outstanding shares at year-end
EPS = ($5 million – $1 million) / 8 million shares
EPS = $0.5 per share
What is a good Earnings Per Share ratio for a company?
What investors would consider a good EPS for a company depends on several factors. As mentioned, the industry that a company works in dictates its EPS ratio. Similarly, the company’s performance also plays a significant role in determining its EPS. In some instances, the EPS of a company may also be deceptive, as it may not reflect its true stock market performance.
As stated above, it is best to use the EPS ratio comparatively, rather than on its own. By doing so, an investor can gain valuable insights into a company’s performance. Similarly, they can get an understanding of what to expect from the EPS.
Conclusion
The Earnings Per Share ratio is a metric used to evaluate the financial performance of a company. It shows the net income of a company per its outstanding number of shares. While it is a great metric to evaluate a company, it is still best to use it comparatively, rather than on its own.
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