The Earnings Per Share (EPS) is a key measure for a company’s profitability since it represents the earnings of the business on a per-share basis. The EPS can be calculated by dividing the total net income of a business within the measured time period by the number of existing shares within the company.
Based on the formula of earnings per share, the only determining factors for an increasing EPS can either be an increase in net income or a decrease in the total number of outstanding shares. A higher net income figure will depend on increasing revenues or lower costs that are associated with that revenue.
If for instance, company ABC has been able to grow its revenue (which increases earnings), enhance its cost efficiencies (increases earnings further), and bought back shares (reduces shares count), the earnings per share for company ABC will be substantially higher than before.
In the following, we will go a little more into detail on each component that affects EPS and which options a company has to increase its earnings per share.
What Is Earnings Per Share?
EPS primarily acts as a measure of a company’s profitability and performance. Usually, investors will keep a close eye on earnings per share as it can be a primary cause of a rising stock price.
A consistently growing EPS of a company may also indicate solid financial health and growth prospects for the future. The formula for earnings per share (EPS) goes as follows:
The earnings per share consists of two primary component net income (also called earnings or net profit), which is the numerator of the equation, and the total amount of shares within the business, which serves as the denominator.
Each component can be a result of the actions and decisions made by a company. A higher numerator in the calculation (net income) will result in a higher EPS, while a lower denominator (number of shares) can also lead to an increased EPS.
Example: Facebook's EPS
The net income of Facebook (FB) for the fiscal year 2020 was $29.146B. If we divide that figure with the number of shares (basic average of outstanding shares) of 2.851B we would come up with an EPS of $10.22 for the company.
Let’s suppose that Facebook had doubled its net income figure to $58.29B. As a consequence, the earnings per share would have also doubled accordingly to $20.44.
Here are a few other major businesses, their share count, net income, and EPS numbers on an annual basis for the year 2020:
|Company Name||Net Income||Share Count||Annual Earnings Per Share|
|Facebook, Inc. (FB)||$29.146B||2.888B||$10.09|
|Apple Inc. (AAPL)||$57.411B||17.528B||$3.28|
|Amazon.com, Inc. (AMZN)||$21.331B||0.51B||$41.83|
|Microsoft Corporation (MSFT)||$44.281B||7.683B||$5.76|
|Tesla, Inc. (TSLA)||$0.69B||1.083B||$0.64|
|Visa Inc. (V)||$10.866B||2.479B||$4.4|
Factors That Lead to an Increase in Earnings per Share
Now that we understand which components EPS really consists of and depends on, let’s get a little deeper into the different factors that can increase earnings per share.
1. Increase in Net Income
Here is the formula of Net Income:
The net income figure is the end resulting profit of a business. It’s essentially the amount of money that a company makes as a profit after subtracting all costs and expenses that are associated with that revenue during the reported time period.
Net income can either increase by
- An increase in revenue. Revenue is the raw income that is generated by the business and its operations. The revenue figure depends on the price of each sold product and the number of products sold. A business can, for example, increase revenue by accomplishing more sales.
- A decrease in costs. All the money that had to be spent to generate that revenue and operate the business costs and expenses that need to be subtracted accordingly. These costs and expenses are generally grouped into several different categories such as costs of goods sold (COGS), sales & marketing, research and development (R&D), taxes, and interest. Any decrease in those categories will result in a decrease bottom line (net income) and thus a higher EPS figure.
2. Decrease in the Total Count of Shares
Each company has a certain number of outstanding shares. The count of shares may always change throughout the lifespan of a company. Since EPS represents the earnings of a company for each share, a decrease in the total amount of shares will result in a higher EPS.
A company can reduce the number of shares outstanding simply by buying back its own stock from the market. This may happen when a company sees the opportunity to return profits back to shareholders or when it can benefit from a share repurchase (for example, to reduce equity financing costs, boost investors confidence or take advantage of undervaluation).
When a business buys back shares, the total count of repurchased shares will be taken out of circulation, which will then result in a lower number of outstanding shares. Because net income (earnings) are now divided by a lower number of shares, the earnings per share (EPS) ratio will automatically increase accordingly.
The earnings per share is an important metric for investors since it can be primarily used to track a company’s performance and profitability over time. Furthermore, EPS plays its role as a component for the PE ratio, which is one of the most common pricing metrics, investors use to assess the value of a stock.
That being said, the earnings per share figure can also be severely flawed because it can easily be distorted by different accounting methods or share repurchase programs. Since most companies know that investors are usually keeping close attention to the earnings per share of a business over time, businesses may always try their best attempt to maximize EPS in the short run, even if that may lead to negative consequences in the long run.