What Does EPS Mean?
Earnings per share (EPS) is a ratio that calculates the amount of net income earned for every outstanding share. In other words, this amount is the money earned by every share if the entire profits are divided at the end of the year. In some ways, it also reflects the profitability of the company from a shareholder's perspective.
It is calculated as:
EPS = (Net Income - Preferred Dividends) / Weighted Average of Outstanding Common Shares
Divestopedia Explains EPS
EPS is available only for common shareholders, which is why preferred dividends are subtracted from net income in the formula to determine the value of earnings available for common stock holders. Moreover, the weighted average is used because this calculation is only done at the end of the year; therefore, it should reflect all the shares that were bought or sold by the company during the entire year. To calculate the weighted average, add the beginning and ending numbers of outstanding shares then divide by two.
From a shareholder's perspective, the higher the EPS the better, as it signifies a higher return on investment. Also, a higher EPS shows that the company is in a favorable financial position as it can distribute more money to its shareholders as profits after all operating expenses are met. This is why EPS is watched closely by shareholders and why a higher EPS causes the share price of a company to increase. However, shareholders prefer not to base their investment decisions solely on EPS as it can be easily manipulated.
Though EPS is mostly used in public companies, it can also be used for private investments. Using the same method of valuation in calculating EPS for private holdings, investors have a better idea of the return on investment as well as the profitability levels of the company.
There are five types of EPS: Reported EPS or GAAP EPS, Pro Forma EPS, Ongoing EPS, Headline EPS and Cash EPS. Out of these, the most commonly used is the Reported EPS, which is the value reported in SEC filings.