- Earnings Per Share (EPS) Ratio — Explanation, Formula, Example and Interpretation
- Example 1 – EPS computation without preferred stock:
- Example 2 – EPS computation with cumulative preferred stock:
- Impact of preferred dividends on computation of earnings per share (EPS)
- Significance and Interpretation:
- PE Ratio Formula | Price to Earnings Calculator (Excel template)
- Examples of PE Ratio Formula
- Significance and Use of Price to Earning Ratio Formula
- PE Ratio Calculator
- PE Ratio Formula in Excel (With Excel Template)
- Recommended Articles
- Price Earnings Ratio — Formula, Examples and Guide to P/E Ratio
- P/E Ratio in Use
- Price Earnings Ratio Formula
- P/E Ratio Formula Explanation
- Why Use the Price Earnings Ratio?
- High P/E
- Low P/E
- P/E Ratio Example
- Download the Free Template
- Video Explanation of the Price Earnings Ratio
- Justified P/E Ratio
- Limitations of Price Earnings Ratio
- Additional Resources
- Earnings Per Share (Definition, Formula) | How to Calculate EPS?
- Simple vs. Complex Capital Structure
- Earnings Per Share Formula
- Example #1
- Example #2
- Example #3
- Effect of Stock Dividends & Stock Splits
- Effect of Stock Splits & Stock Dividends
- Colgate’s Stock Dividends –
- How Earnings per Share is related to the Stock Markets
- Other Resources that you may
Earnings Per Share (EPS) Ratio — Explanation, Formula, Example and Interpretation
Earnings per share (EPS) ratio measures how many dollars of net income have been earned by each share of common stock during a certain time period.
It is computed by dividing net income less preferred dividend by the number of shares of common stock outstanding during the period.
It is a popular measure of overall profitability of the company and is expressed in dollars.
Earnings per share ratio (EPS ratio) is computed by the following formula:
The numerator is the net income available for common stockholders (i.e., net income less preferred dividend) and the denominator is the average number of shares of common stock outstanding during the year. The denominator does not include preferred shares.
The formula of EPS ratio is similar to the formula of return on common stockholders’ equity ratio except the denominator of EPS ratio formula is the number of average shares of common stock outstanding rather than the average common stockholders’ equity in dollar amount.
Example 1 – EPS computation without preferred stock:
Abraham Company had a net income of $600,000 for the year 2019. The weighted average number of shares of common stock outstanding for the year were 200,000. What was the earnings per share ratio of Abraham Company?
Earnings per share = Net income/Weighted average number of shares outstanding=$600,000/200,000
= $3.00 per share
Example 2 – EPS computation with cumulative preferred stock:
Following data has been extracted from the financial statements of Peter Electronics Limited. You are required to compute the earnings per share ratio of the company for the year 2016.
- Net income for the year 2016: $1,500,000
- 6% cumulative preferred stock outstanding on December 31, 2016: $3,000,000
- $15 par value common stock outstanding on December 31, 2016: $2,376,000
The number of shares of both types of stock are same as they were on January 01, 2016 because the company has not issued any new shares of common or preferred stock during the year 2016.
From the above data, we can compute the earnings per share (EPS) ratio as follows:
= ($1,500,000 – $180,000*)/158,400= $1,320,000/158,400
= 8.33 per share
The EPS ratio of Peter Electronics is 8.33 which means every share of company’s common stock has earned 8.33 dollars of net income during the year 2016.
* Dividend on preferred stock: $3000,000 × 0.06 = $180,000
A D V E R T I S E M E N T
Impact of preferred dividends on computation of earnings per share (EPS)
The dividends on cumulative and non-cumulative preferred stock impact the computation of earnings per share differently.
The dividend on cumulative preferred stock for current period is always deducted from net income while computing current period’s EPS even if management does not declare any divided during the period.
However, in case of non-cumulative preferred stock, the dividend is not deducted from current period’s net income unless it is declared by management.
In example 2 above, notice that no information regarding declaration of dividend has been provided. Since the preferred stock given in the example is cumulative, we have deducted the preferred stock dividend of $180,000 (= $3000,000 × 0.06) from net income to obtain the net income available for common stockholders (i.e., $1,320,000).
The dividends in arrears on cumulative preferred stock for previous periods are not deducted from current period’s net income while computing earnings per share of current period. It is because those dividends should have been deducted from the net income of previous periods for computing EPS of those periods.
A D V E R T I S E M E N T
Significance and Interpretation:
The shares are normally purchased to earn dividend or sell them at a higher price in future.
EPS figure is extremely important for actual and potential common stockholders because the payment of dividend and increase in the value of stock in future largely depends on the earning power of the company.
EPS is the most widely quoted and relied figure by analysts, stockholders and potential investors. In many countries, the public companies are legally required to report this figure on the income statement. It is usually reported below the net income figure.
There is no rule of thumb to interpret earnings per share of a company. The higher the EPS figure, the better it is. A higher EPS is the sign of higher earnings, strong financial position and, therefore, a reliable company for investors to invest their money.
EPS figure for only a single accounting period does not reveal the real earning potential of the business and should not be considered enough for making an investment decision.
For a meaningful analysis, the analyst or investor should calculate the EPS figure for a number of years and also compare it with the EPS figure of other similar companies in the industry.
A consistent improvement in the EPS figure year after year is the indication of continuous improvement in the earning power of the company.
Analysts, investors and potential stockholders prefer to use earnings per share ratio in conjunction with other relevant ratios. For example, EPS figure is often compared with company’s per share price by computing price earnings ratio (usually abbreviated as P/E ratio).
The P/E ratio comparison of different companies reveals the reasonability of the market price of a company’s stock. It indicates whether a particular company’s stock at a certain market price is cheap or expensive in relation to similar companies’ stocks trading in the market.
Other matrices that are mostly considered along with earnings per share ratio to judge the justification of stock price include dividend yield ratio and annual dividend per share.
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PE Ratio Formula | Price to Earnings Calculator (Excel template)
Here’s the PE Ratio formula –
PE of Index = Summation of Market Cap of companies comprising the index / Summation of earnings of companies comprising the index
Examples of PE Ratio Formula
Let’s take the example of Apple Inc. to Calculate PE Ratio Using Formula
You can download this PE Ratio Template here – PE Ratio Template
Price per share as of December 14, 2018, ~ $165.48
Annual Earnings per share for year ended Sept 30,2018 = $11.91
PE Ratio is Calculated Using Formula
- Price to Earnings Ratio = (Market Price of Share) / (Earnings per Share)
- PE = 165.48/11.91
- PE = 13.89x
- What is PE Ratio Formula? – Price to Earnings (PE) is one of the most popular ratios formulae is being used by investors for valuing companies and taking investment decisions. It may be interpreted as the amount that investors are willing to pay to receive one unit of earnings. Considering the Apple example, you would have to pay $13.89 for every dollar of earnings from Apple. In other terms, say if Apple’s earnings and share price remain stable at the current level, it needs any investor 13.9 years to recover the share price paid today.
- Breaking down PE Ratio Formula – PE itself does not have much relevance in isolation but needs to be compared across time/companies to make informed decisions. But for that comparison to be uniform, we may need to adjust price and earnings for various anomalies stock splits, one-time gains/losses, dilution effect from convertibles and options, price volatility, etc. For example, take Tata Power Ltd.’s FY17-18 financials, which disclosed loss from discontinued operations of Rs 71.74 cr; we need to consider trailing PE ( price of Dec 14, 2018, and earnings of previous fiscal) of 8.33x which excludes this loss rather than the PE of 8.11x which includes this loss.
- Trailing PE vs Forward PE – Trailing PE is calculated using actual earnings per share over a specified previous time period. Forward PE uses projected earnings per share in its calculation. Trailing PE is more reliable while forward PE could be misleading if estimates are faulty. This section can be deleted: When people talk about PE it is usually trailing PE.
For example, assuming Apple’s earnings growth rate of 11.57% next year (analyst forecast from Nasdaq), forward PE as of Dec 14, 2018, would be 12.45x. For a growing company, the forward PE would be lower than the trailing PE.
- PE of Index– PE of stock indexes gives an indication of the health of the market representing the index and future direction of the stock prices. When the index rises faster than earnings of the companies comprising the index, PE expansion occurs and vice versa. For example, the Sensex PE touched a high of 29 during the dot-com bubble and low of 12 during the sub-prime crisis representing an overpriced and underpriced stock market of India respectively.
- Earnings yield– Earnings yield is the reciprocal of PE ratio, e. Earnings per share / Price per share. So, Apple has an earnings yield of 7% an above calculation which means every dollar invested would generate EPS of 7 cents. The earnings yield of companies is useful when comparing with yields of bonds.
- Modified PE– Investors can also use a modified version of PE by using free cash flow per share instead of earnings in the denominator and adjusting for accounting issues, net debt repayments and capital expenditure needed by the company to continue the operations and expected growth.
Significance and Use of Price to Earning Ratio Formula
- Relative Valuation– PE standardizes stocks across different price and earnings and is a good indicator for identifying overpriced and underpriced stock through comparison across time and peers. Overpriced and underpriced markets/sectors can also be located through this ratio.
For example, consider the following table
|Forward PE (1 yr)||24.7x||12.8x||13.3x|
|Expected earnings growth (5 yr)||12.5%||10.4%||6.2%|
At initial glance, Apple looks more attractive compared to Microsoft considering forward PE. However, the forward PE calculations take into account the high growth estimate of earnings of analysts in case of Microsoft. We cannot compare PE of Microsoft or Apple with Kraft Foods since its an altogether different business with different drivers.
- High PE and Low PE– While we usually interpret high PE as expensive and low PE as attractive stock, there is no single magic number demarcating high and low PE. The normal range for PE could be quite different across industries differing expectations. Hence, it would be wrong to compare the PE of companies belonging to different industries. For example, the technology companies may witness average PE of around 20 backed by high growth rates and high return of equity vis-à-vis textile companies witnessing PE of 8.
- Small cap and large-cap stocks– Small-cap stocks have usually remained attractive due to relatively faster earnings growth. Its easier for a small company to double its size compared to a large company. Accordingly, PE of small caps is usually higher, trading at a premium compared to large caps.
- Growth and Value Stocks– Growth stocks generally have relatively high PE compared to value stocks due to bullish expectations of investors regarding a high growth rate of future earnings. Value stocks are assumed to be underpriced in the market compared to their intrinsic value as perceived by the investor and hence have low PE. You may witness growth stocks in high growth industries pharma while you may find value stocks in the financial industry or commodity producers priced at low valuations.
- Limitations in computation– PE provides room for manipulation since company management can fudge earnings reports for better valuations. Hence EPS calculations have to be monitored closely and adjusted for uniformity in comparison. Furthermore, PE fluctuations would occur due to price fluctuations, hence it is advisable to use average price over a period of time for PE computation. For companies with zero or negative earnings, PE ratio formula is of no use in the case of Tesla Inc. with trailing 12 months EPS of -$10.67. In such cases, relative valuation can be done through the other multiples EV/EBITDA or P/S.
- Limitation in interpretation (leverage and growth)– PE ratio does not account for the impact of debt on valuation and performance. A high debt company may exhibit an attractive PE but may also exhibit higher volatility in earnings. A better metric would be EV/EBITDA in case of comparing companies with different degrees of financial leverage in case of the utility sector. PE also does not tell anything about the growth prospects of a company. A more useful measure to compare firms with different growth rates would be PEG ratio which is PE divided by earnings growth rate for a specified time period.
PE Ratio Calculator
You can use the following PE Ratio Calculator
|Price to Earnings Ratio=||=|
PE Ratio Formula in Excel (With Excel Template)
Here we will do the same example of the PE Ratio formula in Excel. It is very easy and simple. You need to provide the two inputs i.e Market Price of Share and Earnings per Share
You can easily calculate the PE Ratio using Formula in the template provided.
PE Ratio of Apple Inc is Calculated Using Below Formula
Price to Earnings Ratio = (Market Price of Share) / (Earnings per Share)
- PE Ratio = $165.48 / $11.91
- PE Ratio = 13.89x
This has been a guide to Price to Earning Ratio formula. Here we discuss its uses along with practical examples. We also provide you with PE Ratio Calculator with downloadable excel template. You may also look at the following articles to learn more –
Price Earnings Ratio — Formula, Examples and Guide to P/E Ratio
The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share (EPS)Earnings Per Share Formula (EPS)EPS is a financial ratio, which divides net earnings available to common shareholders by the average outstanding shares over a certain period of time. The EPS formula indicates a company’s ability to produce net profits for common shareholders.. It is a popular ratio that gives investors a better sense of the valueFair ValueFair value refers to the actual value of an asset — a product, stock, or security — that is agreed upon by both the seller and the buyer. Fair value is applicable to a product that is sold or traded in the market where it belongs or under normal conditions — and not to one that is being liquidated. of the company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earningsNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement. (or future earnings, as the case may be).
Earnings are important when valuing a company’s stock because investors want to know how profitable a company is and how profitableProfit MarginIn accounting and finance, profit margin is a measure of a company's earnings relative to its revenue.
The three main profit margin metrics are gross profit (total revenue minus cost of goods sold (COGS) ), operating profit (revenue minus COGS and operating expenses), and net profit (revenue minus all expenses) it will be in the future.
Furthermore, if the company doesn’t grow and the current level of earnings remains constant, the P/E can be interpreted as the number of years it will take for the company to pay back the amount paid for each share.
Image: CFI’s Financial Analysis Courses.
P/E Ratio in Use
Looking at the P/E of a stock tells you very little about it if it’s not compared to the company’s historical P/E or the competitor’s P/E from the same industry. It’s not easy to conclude whether a stock with a P/E of 10x is a bargain, or a P/E of 50x is expensive without performing any comparisons.
The beauty of the P/E ratio is that it standardizes stocksStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms «stock», «shares», and «equity» are used interchangeably. of different prices and earnings levels.
The P/E is also called an earnings multiple. There are two types of P/E: trailing and forward. The former is previous periods of earnings per share, while a leading or forward P/E ratioForward P/E RatioThe Forward P/E ratio divides the current share price by the estimated future earnings per share. P/E ratio example, formula, and Excel template.
is when EPS calculations are future estimates, which predicted numbers (often provided by management or equity research analystsEquity Research AnalystAn equity research analyst provides research coverage of public companies and distributes that research to clients.
We cover analyst salary, job description, industry entry points, and possible career paths.).
Price Earnings Ratio Formula
P/E = Stock Price Per Share / Earnings Per Share
P/E = Market Capitalization / Total Net Earnings
Justified P/E = Dividend Payout Ratio / R – G
R = Required Rate of Return
G = Sustainable Growth Rate
P/E Ratio Formula Explanation
The basic P/E formula takes the current stock price and EPS to find the current P/E.
EPS is found by taking earnings from the last twelve months divided by the weighted average shares outstandingWeighted Average Shares OutstandingWeighted average shares outstanding refers to the number of shares of a company calculated after adjusting for changes in the share capital over a reporting period.
The number of weighted average shares outstanding is used in calculating metrics such as Earnings per Share (EPS) on a company's financial statements.
Earnings can be normalizedNormalizationFinancial statements normalization involves adjusting non-recurring expenses or revenues in financial statements or metrics so that they only reflect the usual transactions of a company.
Financial statements often contain expenses that do not constitute a company's normal business operations for unusual or one-off items that can impact earningsNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement. abnormally. Learn more about normalized EPSNormalized EPSNormalized EPS refers to adjustments made to the income statement to reflect the up and down cycles of the economy..
The justified P/E ratioJustified Price to Earnings RatioThe justified price to earnings ratio is the price to earnings ratio that is «justified» by using the Gordon Growth Model. This version of the popular P/E ratio uses a variety of underlying fundamental factors such as cost of equity and growth rate.
is used to find the P/E ratio that an investor should be paying for, the companies dividend and retention policy, growth rate, and the investor’s required rate of returnWACCWACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt.
The WACC formula is = (E/V x Re) + ((D/V x Rd) x (1-T)). This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator. Comparing justified P/E to basic P/E is a common stock valuation method.
Valuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent
Why Use the Price Earnings Ratio?
Investors want to buy financially sound companies that offer a good return on investment (ROI)ROI Formula (Return on Investment)Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will receive in relation to their investment cost. It is most commonly measured as net income divided by the original capital cost of the investment.
The higher the ratio, the greater the benefit earned.. Among the many ratios, the P/E is part of the research processEquity Research AnalystAn equity research analyst provides research coverage of public companies and distributes that research to clients. We cover analyst salary, job description, industry entry points, and possible career paths.
for selecting stocks, because we can figure out whether we are paying a fair price. Similar companies within the same industry are grouped together for comparison, regardless of the varying stock prices. Moreover, it’s quick and easy to use when we’re trying to value a company using earnings.
When a high or a low P/E is found, we can quickly assess what kind of stock or company we are dealing with.
Companies with a high Price Earnings Ratio are often considered to be growth stocks. This indicates a positive future performance, and investors have higher expectations for future earnings growth and are willing to pay more for them.
The downside to this is that growth stocks are often higher in volatility and this puts a lot of pressure on companies to do more to justify their higher valuation.
For this reason, investing in growth stocks will more ly be seen as a riskyRisk AversionRisk aversion refers to the tendency of an economic agent to strictly prefer certainty to uncertainty. An economic agent exhibiting risk aversion is said to be risk averse.
Formally, a risk averse agent strictly prefers the expected value of a gamble to the gamble itself. investment. Stocks with high P/E ratios can also be considered overvalued.
Companies with a low Price Earnings Ratio are often considered to be value stocks. It means they are undervalued because their stock price trade lower relative to its fundamentals. This mispricing will be a great bargain and will prompt investors to buy the stock before the market corrects it.
And when it does, investors make a profit as a result of a higher stock price. Examples of low P/E stocks can be found in mature industries that pay a steady rate of dividendsDividendA dividend is a share of profits and retained earnings that a company pays out to its shareholders.
When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividend..
P/E Ratio Example
If Stock A is trading at $30 and Stock B at $20, Stock A is not necessarily more expensive. The P/E ratio can help us determine, from a valuation perspective, which of the two is cheaper.
If the sector’s average P/E is 15, Stock A has a P/E = 15 and Stock B has a P/E = 30, stock A is cheaper despite having a higher absolute price than Stock B because you pay less for every $1 of current earnings.
However, Stock B has a higher ratio than both its competitor and the sector. This might mean that investors will expect higher earnings growth in the future relative to the market.
The P/E ratio is just one of the many valuation measures and financial analysis tools that we use to guide us in our investment decision, and it shouldn’t be the only one.
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Video Explanation of the Price Earnings Ratio
Below is a short video that explains how to calculate a company’s price to earnings ratio, and how to interpret the results.
Video: CFI’s Financial Analysis Courses.
Justified P/E Ratio
The justified P/E ratioJustified Price to Earnings RatioThe justified price to earnings ratio is the price to earnings ratio that is «justified» by using the Gordon Growth Model.
This version of the popular P/E ratio uses a variety of underlying fundamental factors such as cost of equity and growth rate.
above is calculated independently of the standard P/E. In other words, the two ratios should produce two different results. If the P/E is lower than the justified P/E ratio, the company is undervalued and purchasing the stock will result in profits if the alphaAlphaAlpha is a measure of the performance of an investment relative to a suitable benchmark index such as the S&P 500.
An alpha of one (the baseline value is zero) shows that the return on the investment during a specified time frame outperformed the overall market average by 1%. is closed.
Limitations of Price Earnings Ratio
Finding the true value of a stock cannot just be calculated using current year earnings. The value depends on all expected future cash flowsCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has.
In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF and earnings of a company. Price Earnings Ratio is used as a good starting point.
It means little just by itself unless we have some understanding of the growth prospects in EPS and risk profile of the company. An investor must dig deeper into the company’s financial statementsThree Financial StatementsThe three financial statements are the income statement, the balance sheet, and the statement of cash flows.
These three core statements are intricately and use other valuation and financial analysis methodsTypes of Financial AnalysisFinancial analysis involves using financial data to assess a company’s performance and make recommendations about how it can improve going forward.
Financial Analysts primarily carry out their work in Excel, using a spreadsheet to analyze historical data and make projections Types of Financial Analysis to get a better picture of a company’s value and performance.
Additionally, the Price Earnings Ratio can produce wonky results as demonstrated below. Negative EPS resulting from a loss in earnings will produce a negative P/E. An exceedingly high P/E can be generated by a company with close to zero net income, resulting in a very low EPS in the decimals.
CFI is the official global provider of the Financial Modeling DesignationFMVA® CertificationJoin 350,600+ students who work for companies Amazon, J.P. Morgan, and Ferrari for financial analysts. To continue learning and advancing your career, these additional resources will be helpful:
- Financial Modeling GuideFree Financial Modeling GuideThis financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, more
- Income Statement TemplateIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.This statement is one of three statements used in both corporate finance (including financial modeling) and accounting.
- Balance SheetBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity
- PEG RatioPEG RatioPEG Ratio is the P/E ratio of a company divided by the forecasted Growth in earnings (hence «PEG»). It is useful for adjusting high growth companies. The ratio adjusts the traditional P/E ratio by taking into account the growth rate in earnings per share that are expected in the future. Examples, and guide to PEG
Earnings Per Share (Definition, Formula) | How to Calculate EPS?
Earnings Per Share(EPS) is an important financial metric which is calculated by dividing the total earnings or the total net income with the total number of outstanding shares and is used by investors to measure the company’s performance and profitability before investing, the higher the EPS the more profitable the company.
- It is only reported for shares of common stock
- Non publicly traded firms are not required to disclose EPS calculations
- It provides insight into common shareholders about:
- Future dividend payout
- The value of their shareholdings
When you analyze a company’s financial health, the very first measure that you may want to check its profitability.
The portion of a company’s profit allocated to each outstanding share of common stock is known as EPS. Though its interpretation is relatively easy, however, the calculation is not this simple.
For example, let us have a look at the Colgate Palmolive Earnings Per Share Schedule.
source – Colgate 10K filings
We note that there are two variations – Basic and Diluted EPS in Colgate.
Also, note that stock options and restricted stock units are affecting the total number of shares outstanding.
If this is slightly confusing at this stage, then worry not; the primer on EPS covers the basics and then takes you to the advanced level of Earnings Per Share.
Simple vs. Complex Capital Structure
A company’s capital structure is simple if it consists of only common stock or includes no potential common stock that, upon conversion or exercise, could dilute earnings per common share. Companies with simple capital structures only need to report basic EPS formula.
A complex capital structure has securities that could have a dilutive effect on earnings per common share. As of now, think of the dilutive effect as those securities that lower the Earnings Per Share.
- Complex capital structure has potentially dilutive securities convertible securities, options, or warrants.
- Companies with complex capital structures must report both basic and diluted EPS calculations.
- Diluted EPS calculation under a complex capital structure allows the investors to see the adverse impact on EPS if all diluted securities convert into common stock.
Let us look at the Colgate example again in this context.
Colgate has a complex capital structure – Why? The reason is that their capital structure contains stock options and restrictive stock units that may increase the number of shares outstanding (denominator).
If the number of shares outstanding increases, then the EPS will decrease. Please note in the case of Colgate, the number of shares that increase due to stock options and restricted stock units is 9.1 million for the year 2014.
source – Colgate 10K filings
Earnings Per Share Formula
The basic EPS formula does not consider the effect of any dilutive securities. Here we use the actual earnings and an actual number of issued common shares issued.
EPS calculation in a simple capital structure is as follows
The current year’s preferred dividends are subtracted from net income because EPS refers to earnings available to the common shareholder. Common stock dividends are not subtracted from net income.
Since the number of common shares outstanding may change over the year, the weighted average is used to calculate EPS. The weighted average number of common shares is the number of shares outstanding during the year weighted by the portion of the year they were outstanding. Analysts need to find the equivalent number of whole shares outstanding for the year.
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Three steps to calculate the weighted average number of common shares outstanding:
Identify the beginning balance of common shares and changes in the common shares during the year.
For each change in the common shares:
- Step 1 – Compute the number of shares outstanding after each change in the common shares. The issuance of new shares increases the number of shares outstanding. The repurchase of shares reduces the number of shares outstanding.
- Step 2 – Weight the shares outstanding by the portion of the year between this change and next change: weight = days outstanding / 365 = months outstanding / 12
- Step 3 – Sum up to compute the weighted average number of common shares outstanding.
Let’s take a practical example to illustrate the earnings per share formula.
Hit Technology Inc. has the following information –
- The net income for the year-end 2017 – $450,000
- The preferred dividends paid in 2017 – $30,000
- At the beginning of the year 2017, the common shares outstanding were 50,000 shares. In the middle of the year, Hit Technology Inc. issued another 40,000 common shares.
Find out the earnings per share of Hit Technology Inc.
In the example, we know the net income and the preferred dividends. That means we know all the information needed for the numerator. However, we don’t know the weighted average of common shares outstanding; because we need to calculate that from the data given.
Let’s calculate the weighted average number of common shares outstanding first.
It’s said that at the beginning of the year, the firm had 50,000 common shares. And in the middle, 40,000 new common shares were issued. It means we can consider 50,000 shares for the entire year and 40,000 shares for the last 6 months.
Here’s the calculation –
- Weighted average number of common shares = (50,000 * 1) + (40,000 * 0.5) = 50,000 + 20,000 = 70,000 shares.
Now, we will find out the EPS formula –
- EPS formula = (Net Income – Preferred Dividends) / Weighted Average Number of Common Shares
- Or. EPS formula = ($450,000 – $30,000) / 70,000
- Or, EPS = $420,000 / 70,000 = $6 per share.
Let us take the example of Colgate from the above example, the Net Income (2013) attributable to Common Shareholders is $2,241 million, and common shares outstanding is 930.8 million. EPS calculation of Colgate for 2014 is $2,241 / 930.8 = $2.41
source – Colgate 10K filings
Albatross Inc 2007 Net Income – $1,000,000. Additional data provided below
- 100,000 Class A shares preferred cumulative shares, dividend amount of $2.00/share
- 50,000 Class B shares preferred noncumulative shares, dividend amount $1.50/share
- No Dividend declared or paid in the current year
What will be the numerator of basic EPS for Albatross Inc?
Effect of Stock Dividends & Stock Splits
In computing, the weighted average number of shares, stock dividends, and stock splits are only changed in the units of measurement, not changes in the ownership of earnings. A stock dividend or split shareholders).
When a stock dividend or split occurs, the computation of the weighted average number of shares requires the restatement of the shares outstanding before the stock dividend or split. It is not weighted by the portion of the year after the stock dividend or split occurred.
Specifically, before starting the three steps of computing the weighted average, the following numbers are restated to reflect the effects of the stock dividend/split:
The beginning balance of shares outstanding;
- All share issuance or purchase prior to the stock dividend or split;
- No restatement is made for shares issued or purchased after the date of the stock dividend or split.
If a stock dividend or split occurs after the end of the year, but before the financial statements are issued, the weighted average number of shares outstanding for the year (and any other years presented in the comparative form) must be restated.
Effect of Stock Splits & Stock Dividends
Calculate the weighted average number of shares for the following –
The weighted average number of shares is calculated as per below –
Colgate’s Stock Dividends –
As a result of 2013, Stock Split all historical per share data and numbers of shares outstanding were retroactively adjusted. In 2012, the shares outstanding were 476.1 million, and they almost doubled up to 930.8 million due to the two-for-one stock split.
source – Colgate 10K filings
How Earnings per Share is related to the Stock Markets
Earning represents the profitability of the company and is considered to be the most important indicator of the financial health of the company. Earnings are reported four times a year by the publicly listed companies, and we note that research analysts and investors closely follow this earnings season.
Growing earnings or EPS is a measure of a company’s great performance and, in a way, a measure of returns for the investor. In fact, EPS is direct to the stock markets by the way wide tracked Wallstreet PE Multiple or Price/EPS ratio.
The lower the PE multiple compared to the Industry average PE, the better it is from the point of view of investments and valuations. Stock prices react sharply to quarterly earnings due to the very same connection. For example, below is the share price movement of Blackberry Ltd after the quarterly earnings report.
Note the sharp movements in the stock prices. Learn more about Enterprise Value and Equity Value here
source – Reuters
Other Resources that you may
This article has been a guide to What is Earnings Per Share. Here we learn how to calculate basic eps with weighted average shares, share splits, and stock dividends along with practical examples. You may also learn more from the following articles on Shares
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worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu qualification — cleared all 3 CFA exams, FRM Charterholder, IIT Delhi, IIML; This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs, M&As, Private Equity, Startups, Valuations and Entrepreneurship.