What Exactly Is EPS?
EPS stands for earnings per share and is exactly what the name implies: The earnings or net income figure of a company split up on a per-share basis. To put it in another way, earnings per share measures the profit of a company for each share outstanding. In order to calculate the EPS of a company, take the total net income of a business, and divide it by the number of shares outstanding:
For example, if company A’s net income was $3000 for the last quarter, whereas its number of outstanding shares is 600, the quarterly EPS for company A would be $5. You could say that each share of company A was earning $5 in the last quarter.
Looking at a more practical example, Facebook inc. (FB) had an annual net income of 29,146B for the fiscal year of 2020. The basic average of outstanding shares is 2,851B. Dividing the net income figure by the amount of shares outstanding would lead us to an annual EPS of $10.22 for Facebook.
One way to look at the earnings-per-share is by imagining each share of a company that you own as a scaled-down business that operates at a tiny scale, meaning that it has its own sales and revenues coming in and is also generating very little earnings for you since that is just what EPS represents: The amount of earnings that each share would generate for you as a shareholder.
A higher EPS can be driven by an increase in a company’s earnings or a decrease in the firm’s share count which only makes sense since a business would either have to (1) generate higher profits in order to increase the earnings on a per-share basis, or (2) reduce the number of existing shares so that each remaining share would have more earnings to spare.
What's a Good EPS?
Generally speaking, a “good” EPS should be a positive figure that has a long track record of consistent growth. As an example, a company’s earnings-per-share that has been growing substantially on an annual or quarterly basis can be considered favorable. But in addition to that, an EPS should be considered high relative to the current price of the stock in order to be attractive for investors.
A steadily growing EPS generally indicates that the company is in a strong financial position as it manages to grow from profitable investments and projects.
So now that you’ve got a better understanding of how the EPS metric works and what its components are, you may come to the conclusion that only analyzing one single earnings-per-share figure of a company is not really going to help in any way.
We can’t just take the EPS of two different companies and compare them with each other in order to determine which stock might be the better buy. Not only because of the fact that each company will have different amounts of shares outstanding but also because there are so many other factors (growth, risk, cash flows) that play into the quality of a good investment.
Does the higher EPS indicate that Microsoft is a better company than Apple? No, not necessarily. Both stocks actually performed very similarly over the past 5 years. Since the EPS figure is also based on the share count, there is no way of telling which business is generating more profits. We also wouldn’t be able to assess both companies by comparing the total earnings of each.
As a result, EPS can be misleading in a sense that it doesn’t give us any context on the performance of a business nor how attractive the stock itself is priced an investment.
However, that doesn’t mean that the EPS can’t be analyzed. EPS is actually one of the most important financial figures about a company that CEOs, analysts and investors constantly keep an eye on. The key here is to assess the EPS in relation to some other metric or variable, and there are a few approaches on how we can do that:
- 1. The P/E ratio. The price-to-earnings ratio is arguably the most well-known valuation metric out there and puts the earnings of a stock into perspective to its current market price. The lower the P/E ratio, the more earnings you investors getting relative to the price that is paid in order to acquire the stock.
- 2. Evaluating the trend of EPS values. Instead of just looking at the earnings-per-share that a company currently has, you should also pay attention to how those EPS values have changed in the past. How has the EPS been in the past few years? Is it growing consistently over time, or is it declining? How much has the EPS been growing? Is it relatively easy to project the earnings into the future, or is the EPS constantly fluctuating?
- 3. Assessing how EPS has performed against expectations. On wall street, analysts and corporate executives spend a lot of time and effort on estimating how the company’s earnings are likely to perform in the future. In this regard, an EPS figure can also be considered either good when it has beaten the expectations of analysts and executives, or bad when it underperformed expectations.
While the earnings per share figure purely represent the net income of a company on a per-share basis, it still plays its role as a key measure of profitability for a business. Using the EPS as a benchmark for a company’s performance isn’t only easier but makes much more sense than to solely evaluate the net income.
If a business isn’t profitable, it’s simply not likely going to survive over time. If a business is able to generate growing earnings, it will expand and shareholders will be able to capitalize on that growth. This is also why a growing EPS is one of the key drivers for rising stock prices. Because investors are willing to pay higher prices for companies that grow their earnings.
All public companies are split up into countless amount of shares that are trading on the stock market. If you choose to buy a stock, you essentially buy one ore more shares within a business that you want to invest in.
The price at which you buy a stock plays an extremely important role in your investment return. You can utilize the EPS of a company by comparing it with the current stock price in order to come up with the P/E ratio, which can give you a better perspective on how much you are truly paying for that stock.