One of the most important financial metrics for investors, EPS gives you an idea of a company's profitability compared to its size. While EPS doesn't tell the whole story of a stock's potential, it can be a valuable tool for comparing companies working within a single sector and narrowing down selections for your portfolio.
Read on to learn more about EPS, what it means, and how to use it as an investor.
What is earnings per share (EPS)?
At its core, calculating a company's earnings per share is an attempt to compare companies directly in terms of the profit they can generate from their resources. Companies of different sizes will each have a unique number of shares issued to the market, making comparing competitors against one another challenging. At its core, EPS is a relative metric that indicates how much was earned by a company's portion represented by one stock share.
Stock analysts calculate EPS by first researching a company's total profit, publicly available every four months in a company's quarterly earnings report. If a company reports a net loss (negative profit), its EPS will also be negative. Total quarterly earnings are divided by the total number of outstanding shares of common stock to produce the EPS. EPS is a measure of profitability — most investors consider a higher EPS to indicate a more profitable and efficient company, which may signify a more solid investment. As a result, a higher EPS also usually correlates to a higher price per share, while lower profitability may be associated with a lower share price.
What is a good earnings per share when evaluating stocks? No definite EPS figure tells investors that a stock is a buy or if they should pass on it because the average earnings per company can vary widely depending on the average margins of the industry you're working in.
For example, companies in the healthcare industry tend to report higher earnings, improving their EPS over companies in sectors with slimmer margins — like the aerospace and heavy machinery industries. For these reasons, it's usually better to compare EPS values to companies within the same sector (or, better yet, to previous figures from the same company) when evaluating investment viability.
Types of earnings per share
There are multiple types of EPS values, with each value providing a different view of a company's financials. The major difference between the multiple types of EPS calculations is the data included in the calculation and how shares are classified when determining the calculation denominator. The following are a few additional types of EPS you may see in your research.
Trailing EPS
Trailing EPS is a significant earnings figure that describes a broader view of a company's recurring earnings. The most significant difference between the trailing EPS and the basic EPS is the earnings figure used in the calculation. While basic EPS usually uses the most recent earnings data produced on a company's quarterly report, trailing EPS uses the summation of the company's earnings from the last 12 months (four quarters). It gives you a more holistic understanding of a company's financial performance.
As anyone who follows major market news knows, earnings can vary widely from one quarter to the next. Trailing EPS can be valuable for long-term investors, as it provides an average estimate of earnings potential over the past year rather than the last few months. Using a trailing EPS figure and comparing it to basic EPS can also provide you with an idea of how much earnings volatility you can expect moving forward.
Forward EPS
Forward EPS is a forward-looking metric that estimates a company's expected earnings per share. It can be another useful data point for investors looking for stocks to add to their portfolios for the long term. This type of EPS is not calculated directly from raw data provided by the company but is instead a projection made by a financial analyst. This means that the forward EPS of a single company might vary across firms depending on who is crunching the numbers. To get a basic estimate of a company's forward EPS, divide its current stock price by its current P/E ratio.
You can use forward EPS calculations to gauge how experts feel about a select company's recent performance. A forward EPS estimate higher than the current basic EPS may indicate higher investor and analyst confidence, while lower expected earnings could indicate reasons for financial worry. Investors interested in growth stocks, particularly, might want to carefully note forward EPS predictions and how they change over time.
Current EPS
Current EPS, sometimes called “basic EPS,” is the most common method to calculate earnings per share. The standard formula for current EPS uses the following formula:
Current EPS = (Net income - preferred dividends) / number of common shares of stock outstanding
Where:
- Net income: A company's total profit after all expenses, taxes and debt interest payments have been deducted, usually found on its quarterly income statement.
- Preferred dividends: If a company offers preferred shares of stock, it might elect to pay preferred shareholders a special dividend before common stock investors see their cut. These dividends were removed from the net income along with taxes and operating expenses.
- Shares of common stock: Each share represents ownership in a corporation and may provide voting rights and a share in the company's profits through dividends or capital appreciation. The number of stock-issued shares can change over time, with stock splits and merges shifting numbers and figure calculations.
EPS is important because it provides a snapshot of a company’s finances. It also offers a more consistent metric to evaluate companies against one another within a singular sector.
What does EPS indicate?
What is the meaning of earnings per share for you as an investor? EPS can provide you with several key insights into potential investment opportunities.
- Profitability: Perhaps the most important reason to calculate EPS, this figure provides you with a direct metric to compare the profitability of companies, regardless of the size difference. Absolute earnings can vary significantly between large and small companies, with larger companies including both higher operating expenses and income in most cases. Comparing earnings alone might favor larger companies that naturally generate higher total profits. EPS levels the playing field by showing how much profit each company generates for each outstanding share of common stock.
- Earnings quality: Examining EPS figures and how they change over time can provide insight into company earnings quality. Consistent growth in EPS over time suggests that a company is likely generating sustainable earnings. On the other hand, erratic or highly volatile EPS figures may indicate that the company's profitability is less predictable, possibly due to non-recurring events or fluctuations in core business operations.
- Potential for future returns: When a company generates profits, it can distribute those earnings to shareholders through dividends or reinvest them to drive growth. A higher EPS suggests the potential for higher dividend payments or increased stock value. It might be essential for investors looking to purchase shares of companies with consistent dividend payments and increasing yield.
Different types of EPS may offer varying insights into a company's future performance potential, and the best kind of EPS value to compare might vary depending on the type of investment you're seeking. For example, growth-oriented investors might want to compare based on the most recent EPS performance. In contrast, retirement investors likely to hold the stock longer might be more interested in historical consistency.
How to use EPS for stock selection
EPS is useful in stock selection because it can provide a way to compare companies of different sizes more accurately than using raw data alone. What earnings per share is good to look for? The answer could vary depending on how others in a similar sector are performing.
For example, imagine you are comparing two companies: Company X and Company Y, which have gross revenues of $500 million. This data may sway you to think that the two companies are equal in performance. However, that might not be the case.
Let's also say Company X brought in $100 million in net earnings in the quarter, while Company Y brought in only $50 million. It might appear that Company X has the upper hand over Company Y at this juncture, which could be true in some sense. If Company X has 50 million shares of stock outstanding and Company Y has only $10 million, Company Y has a higher EPS ($2 per share versus $5 per share). This could indicate that Company Y is producing more value for its stakeholders despite lower profits, which can be a positive indicator for future dividends and capital returns.
Example of EPS use
If you're interested in learning more about how to calculate a company's EPS by hand, check out MarketBeat's article on EPS calculation here. We've also included a quick EPS calculator to automatically calculate EPS based on your inputted company data. Play with the calculator using a few sample sets of data to see how the number of shares a company issues and its net income data can influence EPS.
Let’s look at an example of how you might compare EPS values across companies and use EPS values as an investor. The healthcare sector of the United States is one of the largest industries in the country, representing about 18.3% of the total economy. One of the largest companies in the industry is UnitedHealth Group NYSE: UNH, a multinational healthcare and insurance provider. In September 2023, it had a total market capitalization of more than $444 billion.
In the same month, UnitedHealth Group also showed an EPS of $6.13 per share, a decrease of 13 cents from the previous quarter.
Compare this data to competing health insurance and care service provider, Humana NYSE: HUM. During the same time, Humana showed a total market capitalization of $57 billion — just over 12.8% of the total market cap showcased by UnitedHealth Group. So why is Humana’s share price comparable to the larger, dominating company?
Humana’s higher EPS value could influence part of this. In the same period mentioned previously, Humana showed an EPS of $8.93 despite its smaller size. However, as you can see by the chart below, these earnings were not consistent throughout the year. This could make Humana a less appealing choice for long-term investors, who might prefer the stability and predictability of UnitedHealth.
EPS vs. adjusted EPS
You may have heard the term “adjusted EPS” used when discussing an overall picture of corporate financial returns. What is adjusted earnings per share (EPS), and how does it vary from basic EPS calculation?
Adjusted EPS is a modified version of EPS that excludes certain one-time or non-recurring items from the calculation to provide a clearer picture of a company's core or ongoing profitability. For example, items such as gains or losses from the sale of assets, restructuring charges or impairment charges not expected to recur in the future would all be excluded from an adjusted EPS. Some companies also exclude the cost of stock-based compensation from adjusted EPS calculations.
The purpose of the adjusted EPS is to give you a more accurate understanding of special circumstances that could influence an EPS value. For example, most companies will not undergo mergers multiple times, so including the significant financial cost of completing it in an ongoing EPS calculation might not make sense. The adjusted EPS value can be especially useful for long-term investors and investors learning about assets that have undergone a major structural change recently.
While EPS can be a valuable stock comparison tool, it's important to remember to compare stocks across similar sectors. Additionally, startups and companies that operate in cyclical industries might deserve special considerations beyond EPS to gain a total sense of their value. Like most other financial data points, EPS is best used to compare items within a sector and as a value compared to past data from a single company.
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