Earnings Per Share Formula

Earnings Per Share Formula (Table of Contents)

• Formula
• Examples
• Calculator

What is Earnings Per Share Formula?

Earnings per share (EPS) is the net income of the company allocated among each outstanding common shares. The Earning per share is calculated using the below formula:

If a company has preferred shareholders, then the earning per share is calculated using the below formula:

Assume ABC Corporation’s reported net income for the year FY18 was $10 million and average outstanding common shares for the fiscal FY18 were 5 million. Calculate Earnings per share for the company.

Solution:

Earnings Per Share is calculated using the formula given below

Earnings Per Share (EPS) = Net Income of the Company / Average Outstanding Shares of the Company

• Earnings Per Share (EPS) = $10 million / 5 million
• Earnings Per Share (EPS)= $2

Earnings Per Share Formula – Example #2

Assume ABC Corporation has preferred shareholders. The company reported a net income of $10 million for FY18 and declared a total dividend of $0.50 million to preferential shareholders. Total average outstanding common shares of the company were 5 million. Calculate Earnings per share for the company.

Solution:

Earnings Per Share is calculated using the formula given below

Earnings Per Share (EPS) = (Net Income of the Company – Dividend to Preferred Shareholders) / Average Outstanding Shares of the Company

• Earnings Per Share (EPS)= ($10 – $0.50) million / 5 million
• Earnings Per Share (EPS) = $1.90

Earnings Per Share Formula – Example #3

Assume ABC Corporation reported a net income of $10 million for the fiscal FY18. The common outstanding shares of the company at the start of fiscal FY18 were 5 million. During the fiscal FY18, the company had made a buyback of 1 million common shares from the open market. The company doesn’t have preferential shareholders as per reported financials for FY18.

Solution:

After buyback of 1 million shares, total common shares outstanding at the end of FY18 =4 million

Assuming the company buyback plan was executed in the end of June 2018, the weighted average common outstanding shares for the Company are

= ((6months/12 months) *(5 million)) + ((6months/12 months) *(4 million))

= (½)* (9 million) = 4.5 million shares

Weighted average common outstanding shares = 4.5 million

Earnings Per Share is calculated using the formula given below

Earnings Per Share (EPS) = (Net Income of the Company – Dividend to Preferred Shareholders) / Average Outstanding Shares of the Company

• Earnings Per Share (EPS) = ($10 – $0) million / 4.5 million
• Earnings Per Share (EPS) = $2.22

If we compare the example 1 and example 3, the buyback of the shares reduces the total common outstanding shares and hence improves the earning per share for the company.

Relevance and Uses of EPS Formula

The investors in the financial world use multiple valuation metrics to value a company’s share prices and also to compare the valuation of companies in a specific industry. When earnings per share (EPS) is used on a standalone basis, it does not really tell much about a company and it is not very useful. Because earnings per share use a number of common shares outstanding in denominator while calculating EPS and value for a share for different companies may be different. Therefore, it may not give a fair view of the earnings of companies in a specific industry if prices of shares (equity capital) of companies are different.

To demonstrate the above, I have taken an example of three companies operating in the same industries. All the financial numbers such as net income, number of shares, the price per share are taken for the financial year 2018.

As we can see in the above table that earnings per share for all three companies are the same, however, this is not a correct indicator of earnings. Because Company XYZ Corporation generates the same amount of earnings with a lesser share capital than the company’s ABC Corporation and PQR Corporation. Therefore, we can’t really be sure about the earnings performance of all three companies even though all have the same earnings per share. Therefore, earnings have to be compared in association with the share price of the companies.

Very useful and important metric for valuation when used with the price of the share

If earnings per share are used along with the price of the share, it gives a fare view on the valuation of the share of a company. When we combine earnings per share and price of the share for analysis, we come across a very widely useful metrics i.e. P/E ratio.

P/E Ratio= Price Per Share of the Company / Earnings Per Share of the Company

Now let’s look at the below table, wherein the P/E ratio has been calculated and included in the table:

We can see from the above table that PQR Corporation has the highest P/E ratio and XYZ Corporation has the lowest P/E ratio. Which means PQR Corporation is relatively higher valued than XYZ Corporation and ABC Corporation. This can give important insight to investors (along with other financial metrics) on the relative valuation of the company. A lower P/E ratio indicates a lower valuation and many time makes a company/stock an attractive bet for investments (if other fundamentals of the company are intact). 

So the bottom line is if earnings per share are used with the price of the share and P/E ratio is derived using the two metrics, it is an important and widely used valuation metric for investor community.

Earnings Per Share Formula Calculator

You can use the following Earnings Per Share Calculator

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