Earnings Per Share (EPS) Explained - The Definitive Guide for New Zealand Investors
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Updated 25 July 2022
With the rise of investment platforms like Sharesies, Stake, and Hatch, it's never been easier to research stocks and invest in your future. However, knowing which number to look at is incredibly confusing with so many different tools at our disposal. In addition, with many complicated ratios, percentage figures and valuations, it's never been more important to understand the core financial metrics to make better investment decisions. One of those important metrics is earnings per share.
This guide will explain what earnings per share is, how companies can show earnings per share and what to be careful of when looking at earnings per share. We'll also walk through the must-know facts you need to know and the most frequently asked questions New Zealanders have regarding earnings per share.
Our guide covers:
With the rise of investment platforms like Sharesies, Stake, and Hatch, it's never been easier to research stocks and invest in your future. However, knowing which number to look at is incredibly confusing with so many different tools at our disposal. In addition, with many complicated ratios, percentage figures and valuations, it's never been more important to understand the core financial metrics to make better investment decisions. One of those important metrics is earnings per share.
This guide will explain what earnings per share is, how companies can show earnings per share and what to be careful of when looking at earnings per share. We'll also walk through the must-know facts you need to know and the most frequently asked questions New Zealanders have regarding earnings per share.
Our guide covers:
- What are Earnings Per Share (EPS)?
- How do I Calculate Earnings Per Share?
- How Is Earnings Per Share Used?
- Key Adjustments to Earnings Per Share
- A Must-Know Summary of Earnings Per Share
- Frequently Asked Questions
What are Earnings Per Share (EPS)?
Earnings per share is calculated as a company's income divided by the company's number of shares. In essence, it is the earnings a company makes per share. The greater a company's earnings per share, the more profit it makes per share. Therefore, earnings per share can be a great way to determine how profitable a company is. The total earnings figure is the quantity of money that stays in business after all expenses are deducted.
Earnings per share also takes into account any dividends that are paid out from the company's earnings. As we'll discuss below, any preferred stock that requires a dividend payout will also need to be subtracted, as preferred shareholders have a contractual right to a specific dividend amount each year.
Earnings per share also takes into account any dividends that are paid out from the company's earnings. As we'll discuss below, any preferred stock that requires a dividend payout will also need to be subtracted, as preferred shareholders have a contractual right to a specific dividend amount each year.
How do I Calculate Earnings Per Share?
The balance sheet and income statement are used to find the number of shares issued to calculate a company's earnings per share. Additionally, the dividend amount paid out and the company's earnings are also required to calculate earnings per share. It’s recommended to use the average weighted amount of shares over the reporting period when calculating earnings per share. The number of shares can change depending on whether the company issues new shares or repurchases them. Dividends, stock splits and reverse splits will also impact the earnings per share calculation.
Most of the time, we'll be dealing with "ordinary shares", which are the most common type of shares used in many companies to indicate ownership in the company. The other type of share is the preferred share, which typically has higher voting rights or first preference in the case of liquidation (they get their money back before common shareholders).
Most of the time, we'll be dealing with "ordinary shares", which are the most common type of shares used in many companies to indicate ownership in the company. The other type of share is the preferred share, which typically has higher voting rights or first preference in the case of liquidation (they get their money back before common shareholders).
How Is Earnings Per Share Used?
Earnings per share is one of the most important metrics financial analysts and investors use to identify a firm's profitability. It is the first step in working out other important metrics, such as the price-to-earnings (P/E) ratio, where the E in P/E is the earnings per share. By taking the price of a stock and dividing it by the earnings per share, an investor can determine how much the general market pays for every dollar of earnings. We'll get into some examples of earnings per share and how they can translate to P/E ratios below.
EPS is one of the many metrics you can use to find great stocks. If you've got additional cash to invest or are looking to build your long-term wealth, earnings per share is a great tool to assist you in finding great stocks.
However, comparing earnings per share to other companies isn't the best way to work out profitability, as each business operates in a different industry and may operate completely differently.
For example, if Coca-Cola had $10 of earnings per share in 2010 compared to Pepsi's earnings per share of $8, then for that financial year, Coca-Cola made $2 more earnings than Pepsi. However, this doesn't tell us anything about how fast the company is growing, whether those earnings were put back into the business or paid that money out as a dividend. We also don't know how much money we paid for that $10 of earnings (in other words, the earnings per share do not tell us the price we paid for that share). If one share of Coca-Cola costs us $100,000, suddenly, the company does not look great as we would only make $10 of earnings on a $100,000 cost to buy the stock.
As such, we need to look at more than just earnings per share. However, it does give us a great headstart in understanding profitability, especially compared to loss-making technology companies.
EPS is one of the many metrics you can use to find great stocks. If you've got additional cash to invest or are looking to build your long-term wealth, earnings per share is a great tool to assist you in finding great stocks.
However, comparing earnings per share to other companies isn't the best way to work out profitability, as each business operates in a different industry and may operate completely differently.
For example, if Coca-Cola had $10 of earnings per share in 2010 compared to Pepsi's earnings per share of $8, then for that financial year, Coca-Cola made $2 more earnings than Pepsi. However, this doesn't tell us anything about how fast the company is growing, whether those earnings were put back into the business or paid that money out as a dividend. We also don't know how much money we paid for that $10 of earnings (in other words, the earnings per share do not tell us the price we paid for that share). If one share of Coca-Cola costs us $100,000, suddenly, the company does not look great as we would only make $10 of earnings on a $100,000 cost to buy the stock.
As such, we need to look at more than just earnings per share. However, it does give us a great headstart in understanding profitability, especially compared to loss-making technology companies.
Key Adjustments to Earnings Per Share
Different companies can treat their earnings very differently. Whilst most US-listed companies follow the Generally Accepted Accounting Principles (GAAP) when reporting financial statements, adjustments to earnings per share can distort the real financial situation.
For example, Tesla was profitable much earlier because they had carbon tax credits from the government for producing eco-friendly cars. Unfortunately, this did not mean that the company's car manufacturing business was profitable or had positive earnings. However, the company could report positive earnings due to this adjustment to its financial statements.
Many adjustments like the example above occur for every company. The key adjustments include adjusting the number of shares for dilution (such as restricted stock units, stock options, convertible debt, or warrants).
These three terms are defined as:
Other than the above, there are a few other adjustments that kiwis need to be aware of:
For example, Tesla was profitable much earlier because they had carbon tax credits from the government for producing eco-friendly cars. Unfortunately, this did not mean that the company's car manufacturing business was profitable or had positive earnings. However, the company could report positive earnings due to this adjustment to its financial statements.
Many adjustments like the example above occur for every company. The key adjustments include adjusting the number of shares for dilution (such as restricted stock units, stock options, convertible debt, or warrants).
These three terms are defined as:
- Restricted Stock Units (RSUs) are a form of compensation issued to employees. RSUs are typically common stock issued to employees to incentivise high-quality work and commitment to the company. Still, they are typically not able to be sold for a certain period (anywhere from a few months to years). So instead, these RSUs will typically "vest" (get given out to employees over time) over several years (for example, 25% each year for four years).
- Stock options are an alternative means of compensation that gets issued to employees. It is a derivative contract that gives the employees the right to purchase the stock at a specific price (commonly known as the strike price). Stock options have the impact of diluting existing shareholders (as more stock is being issued at discounted prices).
- Convertible debt is a form of debt where the owner of the debt has the option to convert their claim into equity (shares) if they choose to. Convertible debt has the effect of diluting existing shareholders.
- Warrants are contracts that give the holder the right (but they aren't obligated to do so) to purchase (or sell) shares in a business. As a result, warrants are typically dilutive to businesses.
Other than the above, there are a few other adjustments that kiwis need to be aware of:
Basic Earnings Per Share Versus Diluted Earnings Per Share
Public businesses disclosing earnings per share will typically split their standard/basic earnings per share and their "diluted" earnings per share, which considers all of the above. Therefore, using the diluted earnings per share is typically much better to understand the true earnings attributable to you as a shareholder (or prospective shareholder).
Earnings Per Share Excluding Extraordinary Items
Earnings per share may be distorted, either deliberately or unintentionally, through "extraordinary items". Financial analysts use specific earnings per share definitions to avoid costs or revenues that may influence future earnings per share. Many examples are seen where a company generates profits from one-off transactions or activities. Generally, this is excluded from earnings per share as that level of profitability can't be repeated consistently, so that it would distort the financials for shareholders and investors. It's possible to mislead shareholders if the one-off profits from the transaction were included in earnings per share, leaving the company liable for lawsuits. Extraordinary items also apply to losses (as not every transaction or activity will result in profits).
EPS From Continuing Operations
In some circumstances, companies can undergo a restructuring involving selling off portions of their business. Financial analysts are concerned with the earnings per share expected from the actual operations of the company rather than the historical earnings of the company. As such, they may exclude certain items in the financial statements if those corresponding earnings are no longer likely to be generated.
A Must-Know Summary of Earnings Per Share
- Earnings per share (EPS) is a company's earnings divided by the total number of outstanding shares.
- Earnings tell us how much cash/profit a company makes each year for every share it has. This metric is broadly used for estimating a company’s profitability and ultimate value.
- The greater the earnings per share, the higher the price buyers will be willing to pay.
Chris’s Section
[Chris to add bearish commentary on New Zealand companies and how difficult it can be to reach profitability - NZ focus]
Frequently Asked Questions
What is considered high earnings per share?
What counts as high earnings per share will depend on things such as the most recent performance of the company relative to its history, the overall profitability and comparable earnings of its competitors in the same industry, and the market expectations that the financial analysts who research the company expect.
Likewise, poor earnings per share is likely a result of either a substantial unexpected reduction in earnings compared to what financial analysts expect, lower earnings compared to competitors or lower earnings compared to the company's historical financial figures.
While a company's earnings per share may be good or bad in any particular year, it's important to look at a longer timeframe to identify whether a company's earnings per share is good or bad versus competitors. Generally, earnings are extremely volatile and can be subject to market and macroeconomic factors (such as COVID-19). Therefore, it's recommended to take an average of the last five years worth of earnings when calculating the earnings per share for a company.
Likewise, poor earnings per share is likely a result of either a substantial unexpected reduction in earnings compared to what financial analysts expect, lower earnings compared to competitors or lower earnings compared to the company's historical financial figures.
While a company's earnings per share may be good or bad in any particular year, it's important to look at a longer timeframe to identify whether a company's earnings per share is good or bad versus competitors. Generally, earnings are extremely volatile and can be subject to market and macroeconomic factors (such as COVID-19). Therefore, it's recommended to take an average of the last five years worth of earnings when calculating the earnings per share for a company.
What Are Some Limitations of Earnings Per Share?
There are some drawbacks to using earnings per share as the sole metric for buying or selling a stock. For example, CEOs can easily adjust the earnings per share numbers through accounting loopholes to show whatever numbers they want and label it "adjusted earnings per share". That's why it's important to understand what inputs go into a company's earnings per share calculation. Additionally, earnings per share don't tell whether a company is overvalued or undervalued. That said, earnings per share is a great starting point for investors to understand a company's underlying profitability.
Which Type of Earnings Per Share is the Best to Use?
There aren't any "best" earnings per share metrics to use. What makes a great earnings per share figure will likely vary from company to company. However, you'd generally want to ensure that all dilution is accounted for and that your earnings figure is the most accurate and reliable. In addition, using an earnings number that the business can be relied on to generate over time will be much better than using an extremely volatile earnings figure that is unlikely to be achieved in the future.
What Websites are the Best to Calculate Earnings Per Share?
While it's recommended to calculate earnings per share yourself so you have a better understanding of what went into that calculation (as many financial analysts can cut corners and not include certain things which will distort the result), it's not always practical to do this.
There are many websites online that automatically display earnings per share for many different companies and industries. These websites are a quick and cost-effective alternative to calculating earnings per share. Some of the top websites that provide this include: To find the earnings per share on these websites, type in the stock ticker (usually a three or four-letter code that stock exchanges use to identify a company) into the search bar of these websites and scroll through to the financials section of the analysis.
There are many websites online that automatically display earnings per share for many different companies and industries. These websites are a quick and cost-effective alternative to calculating earnings per share. Some of the top websites that provide this include: To find the earnings per share on these websites, type in the stock ticker (usually a three or four-letter code that stock exchanges use to identify a company) into the search bar of these websites and scroll through to the financials section of the analysis.
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