Individual stocks may be beneficial for investors who need to diversify their portfolios beyond mutual funds and ETFs. However, before purchasing specific stocks, you must be able to assess their underlying businesses. A corporation’s Securities and Exchange Commission filings are a helpful starting point. These papers will contain a wealth of information, including the most recent year’s financial statements. From there, you may compute financial ratios to better understand the company and the stock price direction. One of the essential ratios to consider when analyzing a stock is earnings per share (EPS).
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What Exactly Is Earnings Per Share (EPS)?
Genuinely, earnings per share (EPS) is determined by dividing a company’s net income by the number of outstanding shares of its common stock. The outcome serves as a measure of a company’s profitability. It is typical for a corporation to present EPS that has been adjusted for unusual factors and probable share dilution. Significantly, the greater a company’s EPS, the greater its perceived profitability.
3 Types of Earnings Per Share (EPS)
There are three primary categories of numbers that may be generated with EPS.
1. Trailing EPS
A company’s trailing EPS is calculated using data from the prior year. In actuality, a trailing EPS is calculated using earnings from the prior four quarters. It offers the advantage of using real numbers rather than forecasts.
Significantly, most P/E ratios are computed based on the most recent earnings per share (EPS) since it reflects real events rather than speculation. Alternatively, although the value is true, the trailing EPS is sometimes seen as old news. Many investors will also consider the present and projected EPS.
2. Current EPS
Generally, this metric incorporates data from all four quarters of the current fiscal year, some of which may have already passed and some of which are still to come. Consequently, part of the data will be derived from actual statistics and some from forecasts.
3. Forward EPS
The forward EPS is computed using forecasts for some future time period. It is usually the coming four quarters.
Analysts or the company itself develop forward-looking EPS predictions. Despite the fact that this statistic is based on projections and not real facts, investors are often particularly interested in the forward EPS. This is because investment is generally based on estimates of a company’s future earning potential.
In addition, investors frequently compare these three EPS computation methods. For instance, they may compare the future EPS, which is based on estimates, against the actual EPS for the current quarter. If the actual EPS falls short of the projected EPS, the stock price may decline as investors express their dissatisfaction. On the other side, if the actual EPS exceeds its forecasts, the stock price may increase.
The Importance of Earnings Per Share
The most important aspect of EPS is that it is a measure that may be used to predict a company’s present and future financial performance. It is the proportion of a company’s net income given to each outstanding share of ordinary stock.
A Variable Contributing to the Price/Earnings (P/E) Ratio
EPS is also a significant factor in deciding the value of a stock. This metric is included in the earnings element of the price-to-earnings (P/E) ratio. The P/E ratio is one of the most prominent ratios used by investors to assess whether the stock price of a business is appropriately priced relative to its earnings. It is determined by dividing the EPS by the stock price.
Investors and Analysts’ Use
Generally, investors and analysts use EPS to evaluate a company’s financial health. In fact, it is frequently referred to as the company’s bottom line, both literally and metaphorically.
A greater EPS indicates that a corporation is profitable enough to increase shareholder payouts. For instance, a company may boost its dividend as its earnings grow. Normally, investors analyze the EPS of two or more companies within the same industry to gauge a company’s performance relative to its competitors.
In addition, investors may also examine EPS growth trends over time to have a better understanding of a company’s profitability, profit growth consistency, and potential for future performance. A company with a consistently rising EPS is viewed as a more reliable investment than one whose EPS is declining or fluctuating significantly.
How to Calculate Earnings Per Share (EPS)
Calculating earnings per share (EPS) involves assigning a company’s net income to each outstanding share of ordinary stock. After accounting for costs and expenses, a company’s net income is the amount of profit available to shareholders.
The Formula for Calculating Earnings Per Share
The calculation employs the average number of shares outstanding. Since firms may issue or repurchase stock throughout the year, it is difficult to determine the exact number of outstanding shares and the genuine earnings per share. Using the average number of outstanding shares can offer an accurate depiction of the company’s earnings.
Limitations of Earnings Per Share (EPS)
When using EPS to make an investment or trading decision, it is important to be aware of several potential downsides. For example, a corporation can manipulate its EPS by repurchasing stock, lowering the number of outstanding shares, and inflating the EPS figure given the same profit level. EPS can be affected by changes to the accounting policy for reporting results. Moreover, EPS does not account for the share price. Hence, it provides no insight into whether a company’s stock is overvalued or undervalued.
Conclusion
To conclude, when investors examine both past and future EPS data for the same company or when they compare EPS figures for companies within the same industry, the earnings per share figure is very significant. For example, Bank of America Corporation (BAC) operates in the financial services industry. Investors can measure the relative financial health of Bank of America by comparing its earnings per share to those of other financial organizations, such as JP Morgan Chase (JPM) or Wells Fargo (WFC). In addition, as EPS is only one statistic that may be used to evaluate a company’s financial prospects, it is crucial to utilize it with other performance metrics prior to making investment decisions.
FAQs
EPS is a financial metric that represents the portion of a company’s profit that is allocated to each outstanding share of common stock.
EPS is an important metric because it provides insight into a company’s profitability and can be used to compare the earnings of different companies.
EPS represents a company’s net income divided by the quantity of outstanding common stock shares, whereas revenue represents the total amount of money obtained by a company’s operations.
The frequency relies on the company and the regulatory requirements of the company’s home country. Companies are typically required to report EPS quarterly and annually. However, some businesses may also report EPS monthly or biannually.
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Source: Investopedia