How to Calculate EPS?

Understanding EPS

Earnings per Share or EPS is the portion of a company’s profit that is allocated to each individual outstanding share.

In this article, we will elaborate on the methods of calculating EPS. In order to understand the calculation, we must first understand the different types of Capital Structures as follows.

Types of Capital Structure – Simple and Complex

A company’s capital is composed of its equity & debt. Equity can further be divided into preferred stock & common stock. Whereas sometimes debt & other debt instruments can be converted into equity.

When a company has issued financial instruments that are potentially convertible into common stock, it is said to have a complex capital structure. If a company’s capital structure does not include such potentially convertible financial instruments, it is said to have a simple capital structure.

It is important to understand this differentiation in the capital structure as it will help us understand basic EPS & diluted EPS.

Basic EPS vs. Diluted EPS

In a company with complex capital structure, if all the potentially convertible financial instruments are converted into common stock & then the EPS is calculated, then the resultant EPS will be diluted EPS. In contrast, a basic EPS is calculated using only the common stock of the company (not other convertible debt). When any financial journals mention “EPS” it is usually referring to basic EPS.

How to Calculate EPS?

In this post, we will limit our discussion to the calculation of basic EPS.

By definition, basic EPS is the amount of income available to common shareholders divided by the weighted average number of common shares outstanding over a period. Some companies might have preferred stock. The dividends paid on preferred stocks should be deducted from net income for calculating basic EPS. Thus formula of basic EPS is:

Formula

Basic EPS = (Net Income – Preferred dividends)/ Weighted average number of common shares outstanding

  • If the company doesn’t have preferred stock then preferred dividends would be zero.
  • The weighted average number of shares outstanding is a time weighting of common shares outstanding. In simple words, the shares are averaged out on the basis of how much time the shares have been outstanding.

We will be able to understand the concept better with some examples.

Examples

Example 1:

For the year ended 31 December 2017, XYZ Company had a net income of USD 2,250,000. The company had 1,000,000 shares of common stock outstanding. No repurchases or new issues, no preferred stock, & no convertible financial instruments.

Therefore, Basic EPS of XYZ Company

= (Net Income – Preferred dividends)/ Weighted average number of common shares outstanding

= (2,250,000 – 0)/ 1,000,000 = 2.25

So Basic EPS = USD 2.25 per share.

Example 2:

For the year ended 31 December 2017, ABC Company had net income of USD 2,500,000. The company declared and paid USD 200,000 of dividends on preferred stock. The company had also made following changes to its common stock during the year:

  • Shares outstanding on 1 January 2017 (A) – 1,000,000
  • New Shares issued on 1 April 2017 (B) – 200,000
  • Shares repurchased on 1 October 2017 (C) – (100,000)
  • Shares outstanding on 31 December 2017 (A)+(B)-(C) = 1,100,000

Step 1 – Calculating weighted average number of shares outstanding:

1,000,000 x (3 months/ 12 months) (Outstanding from 1 January to 31 March 2017 – 3 months)250,000
1,200,000 x (6 months/ 12 months) (Outstanding from 1 April to 30 September 2017 – 3 months)600,000
1,100,000 x (3 months/ 12 months) (Outstanding from 1 October to 31 December 2017 – 3 months)275,000
Weighted average number of shares outstanding (250,000 + 600,000 + 275,000)1,125,000

Step 2 – Calculating Basic EPS of ABC Company

= (Net Income – Preferred dividends)/ Weighted average number of common shares outstanding

= (2,500,000 – 200,000)/ 1,125,000 = 2.04

So Basic EPS of ABC Company = USD 2.04 per share

Thus we can interpret it as, for every common share the company has outstanding, the company has earned USD 2.04.

You can also use our calculator for calculating EPS.

Interpretation of EPS

Usually, investors believe that higher the EPS, the better. This is true to an extent as the higher the EPS, the more profitable the company is and there are higher chances that company will pay out higher dividends on common stock. But it is important to understand that EPS as a measure by itself, will not give any definitive indication to the financial health of the company. To establish the strength of EPS, analysts compare the present EPS with that of historical EPS of the same company. For example, basic EPS of Apple Inc. was USD 8.35 in September 2016 & USD 9.27 in September 2017, which means company’s profitability increased. Furthermore, the analysts also compare a company’s EPS with that of its competitors to understand its standing in the market. Thus we can conclude that all other things equal, a company with higher EPS is more profitable & financially strong.

Reference

BOOKS:

Financial Reporting & Analysis, CFA level 1, CFA Institute

Last updated on : July 7th, 2018

** Disclaimer: This post may contain Affiliate Links marked as ** and we may earn a commission on sale.

What’s your view on this? Share it in comments below.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.