Investing Series: What does EPS or Earnings Per Share mean?

This is a part of the Investing Series.

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Earnings per share is really as easy as it sounds, it is just how much a company has earned in relation to how much stock they’ve issued.

So you could ask the questions when you’re evaluating a company:

If a company has earned $100 million in a year, how much of that $100 million is allocated to each stock?

If I own 100 stocks, is it $1000 per stock? $10 per stock?

That’s all basic earnings per share means.

HOW TO CALCULATE BASIC EARNINGS PER SHARE

This is going to sound complicated, but it really isn’t:

Basic EPS = (Net Income – Preferred Dividends) / Weighted Common Shares Outstanding

To break down each part:

Net Income = How much a company makes per year

Preferred Dividends = How much a company gives to each preferred stockholder (this is not the same as a common stockholder!)

• Read: What’s the difference between preferred and common shareholders?

Weighted Common Shares Outstanding = How many common stocks have been issued by the company

LET’S DO AN EXAMPLE OF BASIC EARNINGS PER SHARE

Let’s do Verizon today!

You could just take the shortcut and look at Google Finance to tell you that it is $0.40 for every $50.56 share you own.

Or you can do it the long way (once) to see if you get about the same number:

Net Income = $875,000 (in thousands)

Preferred Stock (which would indicate there are preferred dividends as well) = $0

..which would give us the NET INCOME applicable to common shares:

Common Shares Outstanding = 2.86 B (as in billions)

But those common shares outstanding need to be converted into weighted average shares outstanding.

WAIT BUT HOW DO YOU CALCULATE WEIGHTED SHARES OUTSTANDING?

This is where it gets tricky.

Let’s say a company has 50,000 shares at the start of the year. Midway through, they issue another 50,000 shares.

The calculation would look like this:

50,000 at the start of the year x 0.5 (first half the year)

= 25,000 as weighted shares

100,000 midway through the year x 0.5 (half the year, or the rest and last half of it)

= 50,000 as weighted shares

Weighted Shares = 25,000 + 50,000 = 75,000 to use in the EPS.

You have to take all of that into account to come up with an average for the whole year.

This still doesn’t help us, because it means we’d have to go through each company statement filed of how many shares issued at what dates, and do exactly the above, but a lot more complicated.

SO WHERE DO WE GO FROM HERE?

We take a look at their SEC filings to see if the form 10-12G pops up.

This SEC form tells us when a corporation issues more company stock.

For all of 2013, it looks like it’s mostly normal, mandatory SEC filings, and no 10-12G forms, so we can (for now), take that 2.86 billion as the common shares outstanding as our number.

PUTTING IT ALL TOGETHER NOW!

Basic EPS:

(Net Income – Preferred Dividends) / Weighted Common Shares Outstanding

(Don’t forget to normalize the bases when doing calculations, because the net income was in thousands but the shares were in billions)

($875,000,000 – $0) / 2,860,000,000 = $0.305944

…or about $0.30 per share, which would be $0.30 / $50.63 = 0.60%

It is off from Google’s $0.40, but it could have been which numbers I used, or they used.

There you have it.

THIS DOESN’T SOUND LIKE A GOOD DEAL!

Ah but don’t forget that companies pay dividends too, so while their EPS may not look so hot, their dividend yields look better at $0.51 per share for a yield of 4.07%:

EPS is just a metric to see how a company is doing, but don’t focus on it by itself. Use it as a filter.

SO HOW DO YOU REALLY WANT TO LOOK AT USING EPS?

As a metric, to see how it looks with ALL the other financial ratios out there.

You may for instance, want to see how much capital they have used to generate such earnings.

A company that is using MORE capital to generate the same earnings as a company that is using less, is not as efficient.

You also want to be aware of how companies can use tricks to make their net incomes look bigger and better, when in fact they’re inflated.

Note: for a more conservative calculation, people also do a fancy calculation with DILUTED EPS, which takes into account that if the company starts to sink, they will have lots of people (who are all ahead of you, the lowly common shareholder in line), calling in their debts.

SUMMARY

• EPS means Earnings per share
• Earnings per share means how much net income a company makes per share issued
• We care about earnings per share because we want to know how much we get per share
• This calculation does not take into account common dividends paid out, only preferred ones
• Use EPS as a single ratio or metric, not as the be-all and end-all