EPS ( Earnings Per Share)
Definition of EPS
EPS stands for "Earnings Per Share," a key metric used to evaluate a company's performance, reflecting the profitability of each share of stock.
Calculation Formula and Explanation
EPS can be calculated using the formula:
Net Income ÷ Number of Outstanding Shares
Formula for Earnings Per Share (EPS)
Net income refers to the profit a company earns during an operating period (usually a year) after deducting all expenses, including taxes.
EPS highlights two important aspects of a company's profitability: earning power and growth potential. Generally, companies with higher EPS demonstrate stronger earning power, while those with lower EPS indicate weaker profitability. Additionally, by comparing the EPS of the previous period with the current period, one can evaluate whether a company’s growth remains stable.
Important Considerations for EPS
The value of EPS primarily rises or falls with changes in net income, but it is also affected by fluctuations in the number of outstanding shares. Therefore, when comparing EPS across different stocks, it is essential to account for factors such as stock splits or share buybacks, which may alter the number of outstanding shares.
Example: Impact of Share Buybacks on EPS
| Net Income (Post-Tax) | Outstanding Shares | EPS |
|---|---|---|
| Year 1: $100,000 | 10,000 shares | $10 |
| Year 2: $90,000 | 8,000 shares | $11.25 |
| Year 3: $90,000 | 7,500 shares | $12 |
For instance, in the first year, Company X has 10,000 outstanding shares and a net income of $100,000, resulting in an EPS of $10. In the second year, after a share buyback reduces the number of shares to 8,000, net income decreases to $90,000, but EPS rises to $11.25. In the third year, with further share buybacks reducing the shares to 7,500, EPS increases to $12, even though the company's profitability remains unchanged.
Applications of EPS
Combining EPS with Price-to-Earnings Ratio (PER)
The Price-to-Earnings Ratio (PER) shows how many times the stock price is the EPS.
PER can be calculated using the formula:
Stock Price ÷ EPS
For example, if a company’s stock price is $5,000 and EPS is $1,000, the PER is 5 (5,000 ÷ 1,000). If the industry average PER is 10, the company's PER may rise to 10, and based on the formula PER = Stock Price ÷ EPS, the stock price could increase to $10,000 (1,000 × 10).
Combining EPS with Payout Ratio
The payout ratio shows the proportion of earnings paid out as dividends to shareholders, calculated as:
Payout Ratio = Dividends Per Share ÷ EPS × 100
A higher payout ratio indicates greater returns to shareholders but leaves the company with fewer retained funds for future investments or uncertainties. It’s essential to balance business needs with shareholder returns.
EPS in Mergers and Acquisitions (M&A)
EPS is also useful in mergers and acquisitions (M&A). Specifically, it can be applied to:
Compare EPS between two companies to determine stock exchange ratios
Predict future value based on EPS growth rates
Estimate the payback period for investments from a risk perspective
However, for general investors, the role of EPS in M&A is usually less relevant.
