# What is earnings per share (EPS)?

## Earnings per share (definition)

Earnings per share (EPS) measures a business's profitability per share. Investors and analysts use it as an indicator of a business’s financial performance.

EPS is a widely used measure of financial profitability. It measures a business’s profit for each share held. EPS is calculated quarterly and annually.

The higher the EPS, the more profit is associated with each share, and the more valuable the share is seen to be.

## How to calculate earnings per share

Earnings per share = (Net profit – Dividends on preferred shares) / Average number of ordinary shares

Where:

• Net profit is revenue minus expenses and taxes
• Dividends on preferred shares is money paid to a special class of shareholder
• Ordinary shares are the type that are traded on the sharemarket

By excluding dividends on preferred shares, EPS focuses on profits connected to everyday shareholders.

The use of 'average outstanding shares' accounts for changes in the number of shares over the reporting period. This helps control for the fact that a company may issue (or buy back) shares during the year.

Example EPS calculation

A business has \$2 million in net profit and will pay \$200,000 to owners of preferred shares. There are 800,000 ordinary shares in the market.

(Net profit – Dividends on preferred shares) / Average outstanding shares

(\$2,000,000 – \$200,000) / 800,000

= \$1,800,000 / 800,000

= \$2.25

The business earns \$2.25 per share.

### Variations of EPS

There are two common ways to calculate the EPS:

• Basic EPS: As described above, this calculation uses the total net profit minus preferred dividends, divided by shares. It's a straightforward indicator of a business's profitability.
• Diluted EPS: This includes convertible instruments which might be turned into shares. A stock option is an example of a convertible instrument. Diluted EPS provides a 'worst-case' scenario for EPS, if all these potential shares came into existence.

## How EPS is used

EPS is useful for investors and analysts when they’re comparing the investment potential of different businesses. A high EPS indicates a business is profitable, potentially leading to higher dividends and a stronger share price.

For shareholders, EPS can influence their perception of a share’s value. Growth in a business’s EPS can boost demand for a business's shares, leading to a higher share price.

## Limitations of EPS

While the EPS is a quick way to measure a business’s profitability, it doesn’t account for:

• the business’s capital structure – a business might have a high EPS due to fewer shares outstanding but might instead have high risks associated with debt
• the way a business generates its profits or how efficiently it uses its assets

For a more complete picture of a business's performance, analysts and potential investors should use EPS along with other measures of the business's financial health, and in the context of how well its industry is performing.

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