What it means
Total profit on its own can be misleading, because a company with 100 million shares and one with 1 million shares are not directly comparable. EPS scales profit down to a single share, so you can compare it with the share price or with the same company's figures from earlier years.
It is the "E" in the price-to-earnings ratio. The calculation starts with net income and then deducts any dividends owed to preferred shareholders, who rank ahead of ordinary shareholders.
What remains is divided by the weighted average number of ordinary shares during the year. A weighted average is used because the share count may change during the period if the company issues new shares or buys some back.
There are two common versions. Basic EPS uses the shares actually in issue, while diluted EPS also allows for shares that could be created from options, convertible bonds and warrants.
Diluted EPS is lower or equal to basic EPS, and it is the more cautious number. EPS is influenced by decisions that do not change the underlying business.
A company that buys back its own shares can raise EPS even when total profit is flat, because the same profit is spread over fewer shares. That is why investors read EPS together with net income and cash flow.
EPS is also not comparable across companies in the way margins are, because it depends on how many shares each company chose to issue. A $5 EPS tells you little unless you compare it with the share price or with the company's own history.
Most listed companies report EPS every quarter as well as every year, and the quarterly figures are watched closely because they are compared with analysts' forecasts. A result that beats the forecast can lift the share price, while a miss can push it down even when profit is higher than last year.
For that reason, management teams pay close attention to how their EPS is built up and how it is explained.
In practice
Real-world examples
Example 1
A listed retailer reports net income of $12,000,000 with 6,000,000 shares and no preferred shares. Its EPS is $2.00. An investor compares this with last year's $1.80 and sees a rise of about 11%.
Example 2
A technology company announces a share buyback that cuts its shares in issue from 10,000,000 to 9,000,000. With profit unchanged at $18,000,000, EPS rises from $1.80 to $2.00. A sceptical analyst points out that the improvement comes entirely from the smaller share count.
Example 3
A start-up has issued stock options to employees, and its basic EPS is $1.00. After adding the shares that could be created if all the options were exercised, diluted EPS falls to $0.90. The board uses the lower figure when discussing the true earnings that belong to each shareholder.
Think of it
EPS is like dividing a pizza among friends. If the pizza (profit) stays the same but more friends (shares) arrive, each person gets a smaller slice.
Formula
Calculation
EPS = (Net income - Preferred dividends) / Weighted average ordinary shares outstanding
Suppose a company reports net income of $5,500,000 and pays preferred dividends of $500,000. Its weighted average number of ordinary shares during the year is 2,500,000.
Profit available to ordinary shareholders = 5,500,000 - 500,000 = $5,000,000.
EPS = 5,000,000 / 2,500,000 = $2.00 per share.
If the share price is $30, the price-to-earnings ratio is 30 / 2.00 = 15 times.Case study
Seen in the real world
Westbrook Logistics is an illustrative, fictional listed company whose chief executive wanted to show earnings improvement at the annual meeting. Net income had been flat at $9,000,000 for three years.
The finance team proposed a buyback that reduced shares in issue from 4,500,000 to 4,000,000. EPS rose from $2.00 to $2.25 without any improvement in the business itself.
An analyst on the call noted that the buyback had been paid for with new borrowing, which increased interest costs. The illustrative lesson is that EPS can rise for financial reasons, so it should be read alongside net income, debt and cash flow.
Watch out
Common mistakes
- Using the year-end share count instead of the weighted average number of shares during the year.
- Forgetting to deduct preferred dividends before dividing by the number of ordinary shares.
- Comparing EPS between companies as though a higher number means a better business, when share counts differ.
Questions
People also ask
What is the difference between basic and diluted EPS?
Basic EPS uses the shares currently in issue, while diluted EPS also counts the shares that could be created from options, warrants and convertible securities.
Does a higher EPS always mean a better company?
No, because EPS can rise through buybacks, accounting choices or one-off gains without any real improvement in the business.
How is EPS used to value a share?
Dividing the share price by EPS gives the price-to-earnings ratio, which shows how many years of current earnings investors are paying for.
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