Earnings per share

Definition

Earnings per share (EPS) is a financial metric that indicates the portion of a company's profit allocated to each outstanding share of common stock. It serves as a key indicator of a company's profitability and is commonly used by investors to assess financial performance and make investment decisions.

5 Must Know Facts For Your Next Test

1. EPS is calculated by dividing net income by the number of outstanding shares of common stock, providing insight into the profitability per share.
2. There are two main types of EPS: basic EPS, which does not consider potential dilution from convertible securities, and diluted EPS, which accounts for all possible shares that could be outstanding if options and convertible securities are exercised.
3. A higher EPS indicates greater profitability and is generally viewed positively by investors, as it suggests that the company is generating more profit for each share owned.
4. EPS figures can significantly impact a company's stock price; when a company reports higher-than-expected EPS, its stock price often rises as investors gain confidence in its performance.
5. Earnings per share is often compared against industry averages or competitor figures to evaluate relative performance within a sector.

Review Questions

• How does earnings per share (EPS) help investors make decisions about a company?
  • Earnings per share (EPS) is crucial for investors because it provides a clear measure of a company's profitability on a per-share basis. By analyzing EPS, investors can gauge how well a company is performing relative to others in the industry. A consistently growing EPS suggests strong financial health and can signal to investors that the company is effectively managing its resources and generating profits.
• What are the differences between basic EPS and diluted EPS, and why are both important?
  • Basic EPS reflects the earnings available to each share of common stock without considering any potential dilution from convertible securities or stock options. In contrast, diluted EPS takes into account all potential shares that could be created through conversions or exercises, providing a more conservative view of earnings per share. Both metrics are important as they give investors insight into both current profitability and potential future performance based on outstanding obligations.
• Evaluate how changes in dividends can affect earnings per share and overall investor perception.
  • Changes in dividends directly impact earnings per share (EPS) since dividends are paid out from net income. If a company increases dividends without a corresponding increase in net income, it may lead to lower retained earnings, potentially reducing future EPS growth. Conversely, maintaining or increasing dividends alongside rising EPS can enhance investor perception, signaling financial strength and stability. Thus, managing dividend policy effectively is crucial for maintaining investor confidence and driving stock performance.

Related terms

dividends: Dividends are payments made by a corporation to its shareholders, typically from profits, reflecting the company's ability to generate earnings.

net income: Net income is the total profit of a company after all expenses, taxes, and costs have been deducted from total revenue, forming the basis for calculating EPS.

market capitalization: Market capitalization is the total market value of a company's outstanding shares, calculated by multiplying the current share price by the total number of shares.