What is earnings per share (EPS)?

One important method of fundamental analysis is assessing earnings per share.

Earnings per share (EPS) is the proportion of a company’s profit that can be attributed to each outstanding ordinary share in the company.

EPS is worked out by taking a company’s net profit and dividing it by the number of ordinary shares on issue:

Net profit after tax ÷ number of shares on issue = EPS

This equation is useful because it gives you a quick insight into a company’s earnings growth from one year to the next.

It also gives you a clearer picture of earnings relative to dividends, as these are also expressed on a per share basis.

 

Why EPS is important?

Earnings growth and future earnings potential are arguably the most influential factors on a company’s share price.

When companies release their annual reports they will include their EPS and how it compares to the previous year. Share prices can often move sharply up or down immediately after a company announces its results as investors quickly decipher them.

It’s a good sign if a company is able to grow its EPS each year. However, having established whether EPS has been growing or falling, try to work out the cause.

Was it from normal, ongoing business operations suggesting that the company has seen a rise or fall in its market share or profit margins? Or was it down to one-off events, such as unusually large expenses or cost cutting, which might have caused an anomaly?

Ideally, a company will be growing its EPS, alongside rising revenue and profit each year, which should cause its share price to rise over time.

 

What are the limitations?

In isolation EPS doesn’t mean a great deal and it should be treated as just one component of your analysis.

There are also reasons why a rise or fall in EPS can be somewhat misleading.

For example, if a company buys back some of its own shares, then there will be less ordinary shares on issue and therefore more earnings will be attributed to each, even though profit could have shrunk.

On the other hand, while falling EPS is generally a negative caused by higher costs or lower revenue, it could have been influenced by a stock split, for example.

A company’s EPS could also be positively or adversely affected by economic factors that are beyond its control and also impacting other companies.

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