Earnings per Share Formula (EPS)

Earnings per Share Formula (EPS)

Earnings per Share Formula Definition: A company’s Earnings per Share (EPS) equals its Net Income / Weighted Average Shares Outstanding and tells you how much in profit it’s earning for each “unit” of ownership in the company.

If you have a public company’s Income Statement, you can calculate Earnings per Share (EPS) by taking Net Income at the bottom and dividing by the weighted average share count in the period:

“Net Income” measures the after-tax profits the company generates from its business operations, side activities, and financial activities, such as paying interest on debt and earning interest income on investments.

You should use the Net Income after the deductions for Net Income to Noncontrolling Interests, Preferred Dividends, etc., (if they exist) because none of these go to to the common shareholders of the company.

An easy way to remember this is that you should always use the bottom-most Net Income figure on the Income Statement to calculate EPS.

Investors often focus on the Earnings per Share metric and favor companies with higher EPS figures that are also growing their EPS more quickly over time.

They often use the EPS number to calculate valuation multiples such as the Price / Earnings or P / E multiple, which equals a company’s Share Price divided by its EPS.

Unfortunately, EPS is also a deceptive metric that companies can easily distort, and it’s more useful for evaluating mergers and acquisitions, not company valuations.

Earnings per Share Formula Variations

In addition to the simple Earnings per Share formula shown above, there are many variations.

For example, you might calculate Basic EPS, which is based on just the company’s common shares outstanding, or you might calculate Diluted EPS.

Diluted EPS also includes the impact of dilutive securities, such as stock options and warrants, that might eventually “turn into” common shares.

For example, if the company has 100 common shares, employee stock options that could turn into 10 shares, and warrants that could turn into 5 shares:

-The Basic EPS would be based on the 100 common shares.

-And the Diluted EPS would be based on the 115 diluted shares.

Here’s a simple example from 3M’s financial statements:

You can also calculate EPS on a trailing (historical) basis or forward (projected) basis:

You could also calculate the “GAAP” (Generally Accepted Accounting Principles) EPS or the “Pro-Forma EPS” that excludes non-recurring and unusual expenses:

The most important point here is consistency: You should always use the same metrics to compare companies.

So, if you calculate the Diluted EPS in a company’s most recent historical year, you should also calculate the Diluted EPS in the most recent year for other companies you are analyzing.

Don’t mix and match different EPS metrics, or you won’t be able to make meaningful comparisons.

Why the Earnings per Share Formula Can Be Deceptive

The biggest problem with EPS is that companies can easily distort the numbers:

1) Accounting Gimmicks – For example, companies could “sandbag” their Net Income in one period by increasing their provisions or allowances or shifting around expenses. Then, the company will look better in the future because it’s starting from a lower baseline EPS.

2) Stock Repurchases – When companies have no other ideas for their huge Cash balances, they love to repurchase stock. Doing this lets them artificially boost their EPS by reducing the “Shares Outstanding” in the denominator – even if their core business has not grown at all.

3) Stock Splits and Reverse Splits – If a company decides to increase or reduce its share count with a 2:1 or 1:2 split (for example), these will also affect the Share Count in the EPS denominator, and you’ll have to adjust all the historical EPS metrics for a proper comparison.

If you want to value companies, you should focus on metrics that are less subject to manipulation, such as EBITDA, EBITDA minus CapEx, Free Cash Flow, or Unlevered Free Cash Flow.

These metrics have their advantages and disadvantages, but they are all more reliable than the simple Earnings per Share Formula.

When the Earnings per Share Formula is More Useful

Many articles and online sources describe EPS in relation to accounting and valuation, but in real life, it’s the most useful for assessing mergers and acquisitions.

If an acquirer’s EPS increases after it acquires another company, the deal is accretive, and if it decreases, the deal is dilutive.

We have a full merger model walkthrough that explains the mechanics, but, in short: When a company wants to acquire another company, the Board of Directors is more likely to approve the deal if it is accretive.

Public companies focus very heavily on their EPS, as higher EPS numbers and more EPS growth please their shareholders.

So, the EPS calculation can give you a quick idea of whether a deal is likely to be approved by both companies.

Also, EPS reflects every single possible funding source for an acquisition: Cash, Debt, and Stock.

An acquirer could use any of these to pay for an acquisition, and they each have different effects.

If it uses Cash, it will lose some interest income in the future (“Foregone Interest on Cash”); if it uses Debt, it will have to pay additional interest expense in the future; and if it uses Stock, its Shares Outstanding will increase.

Each of these – Foregone Interest, Additional Interest on Debt, and Stock Issuances – reduces the acquirer’s EPS, but they do so to different degrees, depending on the company’s stock price and interest rates.

Therefore, EPS is useful in an M&A context because it lets you evaluate the “full impact” of an acquisition.

Metrics such as Pre-Tax Income and Net Income reflect only some of this acquisition funding, so they are less comprehensive than EPS.