EPS (Earnings-Per-Share) measures how much of a company’s net income actually trickles down to each outstanding share.
Any preferred dividends are first taken out of the net income before calculating EPS.
Earnings Per Share can be used to compare the earnings of two or more companies in a similar industry.
Just because one company makes more money than another, it does not mean that the shareholders are better off.
What matters is how much of the money the company makes actually trickles down to each shareholder and that depends on how many shares there actually are.
If two companies had the same number of shares outstanding, the higher EPS Company would have:
- More lucrative earnings.
- Higher percentage of earnings going to each share.
- Potentially lower preferred dividends paid out.
Similarly, if two companies had the same net income, the higher EPS Company would have:
- Fewer shares outstanding.
- Shares that have a higher percentage of ownership in the company.
- Shares that have a bigger claim to profits than the other company.
Hence, the higher the EPS between two companies in the same industry, the more money each share makes.
Let’s say we wanted to evaluate two companies in the same industry like:
- Honda (HMC:NYSE)
- and Toyota (TM:NYSE)
Honda’s Net Income after Preferred Dividends: $6,000,000,000 ($6 Billion)
Honda’s Average Outstanding Shares: 1,500,000,000 (1.5 Billion shares)
Toyota’s Net Income after Preferred Dividends: $5,500,000,000 ($5.5 Billion)
Toyota’s Average Outstanding Shares: 1,000,000,000 (1 Billion shares)
At first look, it seems like Honda is the better company as it made more money (Net Income is higher).
But, as a shareholder, when you see how much of that money actually comes down to each share, your decision might change.
Honda’s EPS: $6,000,000,000 / 1,500,000,000 = $4/Share
Toyota’s EPS: $5,500,000,000 / 1,000,000,000 = $5.5 / Share
As you can see, if you owned one share of Toyota, you would be receiving a higher dollar amount from the profits than if you owned Honda.
Types of EPS
- Current EPS – Uses present projections of Net Income figures
- Trailing EPS – Uses past Net Income figures
- Forward EPS – Uses a future projection of Net Income figures
Advantages of Earnings Per Share
- It is hard to compare apples with oranges and EPS makes it easier to compare companies.
- It is also useful in valuing the share price of a Company’s stock.
- It is used to create ratios which are further analyzed to compare companies.
- The most important ratio it is used for is the P/E Ratio.
Disadvantages of Earnings Per Share
- It does not tell us whether the stock is good to buy or not.
- Management can mess with the financial statements to misrepresent earnings.
- This would cause the Earnings per share to be wrong.
Earnings Per Share is a good estimator of how much money each shareholder is entitled to from the profits of the company.
But like everything that can be tampered with, you have to conduct your own due diligence and calculate your own EPS before making any decisions.