What is earnings per share (EPS)?

Earnings per share (EPS) is a common metric that many ASX investors use. In this article, we explore everything you need to know about EPS

Acronym and coprate sayings on chalkboard - "E.P.S" Earnings Per Share
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Earnings per share (EPS) refers to a formula whereby a company’s profits or net income is divided by the number of shares outstanding. This gives you an indication of how much profit per share is being returned to shareholders. 

EPS is one of several metrics that investors use to help them value a company and decide whether or not to invest in it.

It’s an important concept to understand because it is also used in several other ways to evaluate an ASX company’s appeal for investment. A related metric is the price-to-earnings (P/E) ratio, which we’ll talk more about later.

How to calculate EPS

The formula for calculating EPS is as follows:

EPS Formula

Note that the EPS calculation does not usually use the EBITDA metric, which stands for earnings before interest, taxes, depreciation, and amortisation. 

We mention this because EBITDA is a common substitute for ‘earnings’ in other contexts. However, calculating a company’s EPS typically uses net income, including the costs listed above that the EBITDA metric discards.

You’ll come across companies that do not have an EPS value in your research. They are yet to turn a profit, so their EPS is effectively zero (or even a negative number). This doesn’t mean the company is broke or bankrupt! It usually means they’re in the ‘growth stage’ and focused on maximising revenue over profits.

Basic EPS vs diluted EPS

When analysing a company, the two types of EPS numbers that investors like to look at are basic EPS and diluted EPS. 

They are similar in that they both use the above formula for calculation. However, there is one significant difference. 

Basic EPS considers all shares currently outstanding, as per the formula above. Diluted EPS does the same but adds any shares that the company might have quarantined for items such as share options, warrants, or shares allocated to management or employees as part of their remuneration. 

The diluted EPS metric assumes that all of these shares are issued, as per the formula below:

Diluted EPS Formula

As such, the diluted EPS metric will typically be lower than the basic EPS metric due to including these ‘unissued’ shares in the overall share count. Many investors prefer to use the diluted EPS metric, where applicable, as it is more conservative and takes into account more potential outcomes.

Why is measuring EPS important?

When analysing an ASX company for potential investment, most investors take a long, slow look at the EPS recorded per year and how it has changed over time. 

As EPS effectively measures how much profit is returned to a company’s owners, it provides a good indication of its past performance. 

If a company has been growing its EPS at a healthy rate in recent years, it’s usually a good indication that it will continue to do so. This can indicate the company has the potential to be a successful investment. 

Conversely, if a company’s EPS has been going backwards in recent years, that’s usually a red flag. Sometimes, a company can justify a falling EPS by extraordinary circumstances, so you need to do further research to discover its reasons.

Other uses of EPS

EPS is also essential because it is used to calculate other common ASX shares investing metrics, such as the P/E ratio we touched on earlier. 

The P/E ratio measures a company’s share price relative to its earnings per share. This is an excellent metric for comparing different companies in the same industry or sector. 

For example, if a mining company’s P/E ratio is 15 and the mining industry’s P/E ratio is 20, it might indicate that the company is good at its current share price.

Dividend investors, in particular, will be familiar with the payout ratio. This ratio measures how much of a company’s earnings are paid out in dividends each year. For example, if a company’s EPS is $2 and pays out $1 per share in dividends, it will have a payout ratio of 50%.

 

Last updated 28 April 2022. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.