Understanding Earnings Per Share is vital for day traders, as it can tell them how much money they will be earning on a per share basis, and whether or not a company is worth investing in. EPS is not only the profits trades get back, but can also be used to project the future of a company’s success.
What is EPS:
Earnings per share is how much money shareholders are making back on their investment in a company on a per share basis. It is also beneficial for establishing the growth rate of a company by looking at the EPS over time, however, it is mostly a metric for seeing how well the company is doing for its shareholders.
Companies often release a quarterly report each financial year which investors can use to figure out the EPS, and see if the company has had a successful quarter; the more successful the quarter was for the company, the better the EPS is. US based companies are required by law to release a report each quarter.
The reason EPS is used, rather than just looking at net profit, is because two companies making the same amount of money may have different amounts of EPS based on how many outstanding shares there are. If two companies make $40 million a year but once has twice as many outstanding shares as the other, the company with the least amount of outstanding shares will be the most profitable for traders who have purchased shares.
How to Calculate it:
EPS in its simplest way is net coming divided by the amount of outstanding shares. It’s calculated by taking the net profit away from the preferred dividends, and then dividing that figure by the weight average common sales.
The shares outstanding are the total number of shares held by shareholders, investors, and even staff and partners of the business. The shares outstanding can be deduced by looking at the company’s balance sheet which includes shareholders’ equity, usually at the end of the document. Add the shares outstanding of preferred stock and common stock to find out how many shares are outstanding. If there’s also treasury stock on the balance sheet, it needs to be subtracted from preferred stock and common stock to get the figure of outstanding shares.
In some instances, the weighted average also needs to be calculated, this is necessary when stock splits or more shares are issued. The weighed average is calculated by multiplying the amount of shares outstanding with the time period the shares were active in, i.e 6 months (0.5).
The sums for all of the active periods are then added up to establish the weighted average.
The most common ways of working out EPS is by using the formulas below:
- Net Income ÷ Total Number of Shares Outstanding = Earnings Per Share
- Net Income ÷ Weighted Average of Shares Outstanding = Earnings Per Share
The second formula is more popular with traders as the weighted average accounts for variations of outstanding shares which gives traders a more accurate figure
Other Kinds of EPS
When trades refer to EPS more often than not they mean basic EPS which is the EPS that was calculated above, however, there are different kinds of EPS formulas used for day trades to gauge the most accurate results possible.
- Diluted EPS
This type of EPS takes stock options, warrants, and other contributing factors into account, making calculations even more accurate again. For example, the diluted EPS is worked out by dividing the total income of the financial year with the weighted average of shares. If a company made $20 million dollars this fiscal year and had a weighted average of 40 million shares their EPS would be 0.5 which equals $0.50.
- Trailing EPS
This is the EPS from previous fiscal years, usually traders will look at the EPS from the most recent year. By looking at a company’s past, traders can estimate how they will do in the future. For example, if a company’s EPS improved year after year, trades suspect that the current year should top the previous one too.
- Current EPS
The current EPS is exactly what the name suggests, it’s the prediction of the EPS for the current year. This is gauged by using the information gathered so far in the current year and looking at the predictions for the rest of the year. Current EPS should only be a small contributing factor in the decision to invest or not, as the company is not guaranteed to perform as well as it hopes.
- Forward EPS
Forward EPS looks even further into the future of the company than current EPS as it is the estimated EPS for the following fiscal years. This can be deduced by looking at current and trailing EPS and identifying trends.
Most traders will take all of these types of EPS into account before buying shares in a company to ensure that they will be getting the most from their investment.
What to keep in Mind
Even when looking at different types of EPS and using the formulas above, EPS can still be deceptive.
An accounting method known as “Accural Accounting” can skew results making the EPS look better than it actually is. For example, the profit figures may not include things that have not been paid yet or expenses that have yet to be paid can be written off as paid. Other measures include companies buying back shares at prices that are more than the value of the company so they can drive up the stock price by increasing the EPS.
A cautious investor will examine overall earnings and earnings compared to the cash flow, instead of just taking the earnings at face value. Comparing the EPS to the cash flow is a simple method to spot accrual accounting.
The bottom line:
Although it may be time consuming to work out the EPS using the above formulas, and looking at the diluted, trailing, current and forward EPS, these methods can help traders maximise their earnings by investing in companies they’re sure will benefit them the most on a per share basis.