When entering the stock market and evaluating a company's profitability, it's essential to determine the earnings per share (EPS). There are two ways to calculate an EPS. Both formulas require knowing the preferred dividends rate. So, if you want to know the company’s EPS, you must have the preferred dividend rate.
Earnings Per Share Defined
The Corporate Finance Institute (CFI) explains that the EPS calculation determines a company’s profitability. To determine the EPS value, the calculation divides the company’s net income minus preferred dividends by its total number of outstanding shares. There are two ways to determine the EPS.
First, stockholders must know the stock's preferred dividend rate. You can find your stock preferred dividend rate in the company's preferred stock prospectus. Most companies have a corporate website with a page that is labeled investor relations. The prospectus should be located on this page.
Every mutual fund also provides a prospectus. Check their website or request one. Your financial professional or broker should also provide you with one. Make sure you don’t confuse quarterly net income with fiscal year net income.
Once you have the rate for the preferred stock dividends, you’re ready to use a metric to determine the EPS.
Basic EPS Formula
According to Wall Street Prep, the basic EPS is a metric that levels the playing field among companies. Because it is based on individual shares of common stock, it's a fair way of looking at a company's net profit.
The basic EPS involves dividing the numerator – the net income minus preferred dividends – by the denominator – the company's weighted average shares of common shares outstanding. This share calculation will give you the basic earnings of the company's common stock.
There is also an adjusted EPS notes the Securities and Exchange Commission. This is where analysts adjust the numerator. This usually means eliminating some components of a company's net income that are deemed non-recurring – for instance, a one-time sale of property.
Diluted EPS Formula
The main difference between the basic EPS and the diluted EPS formula is the number of shares calculated, explains the CFI. The diluted EPS formula is (net income - preferred dividends)/the total number of diluted shares outstanding.
Diluted shares outstanding are basic shares plus the exercise of in-the-money options, warrants and other dilutive securities. For example, some employees may have stock options. That stock is waiting in limbo until used. The diluted EPS counts it, but the basic EPS does not.
The result is that the basic EPS may inflate the actual earnings per share that a common shareholder is entitled to.
Know the EPS Metric
Stock market investment decisions start with the fundamentals. Evaluating a company’s earnings lets you truly know the company’s profitability.
The share price of stock enables you to compare it to another company’s stock. It also allows you to determine the price-to-earnings of a company’s stock. Therefore, both preferred shareholders and common shareholders can benefit from the EPS metric.
Use EPS to Measure Profitability
Earnings per share relate a stock's price to a company's actual earnings, so it determines profitability. Generally, the higher the EPS, the better, but you need to consider the number of shares outstanding. Also, be mindful of share dilution.
Share dilution is when the issuer releases additional stock. This reduces the ownership proportion of the preferred shareholder or common shareholder.
Use EPS When Comparing Companies
Whether you're considering common or preferred shares, determining the EPS can help you decide which company to invest in. Comparing the EPS of companies in the same industry will let you know each one’s potential profitability. It will let you know which one is growing or shrinking. Knowing the EPS levels the playing field and gives you a fair means of comparison.
Anne attended University of Akron and went on to have a career in television sales. Working as a commercial property and casualty insurance agent for nine years allowed her to learn about different businesses' needs. She has also owned an advertising agency where she created marketing capaigns for various clients. Anne has written for several publications. She currently resides in Charleston, SC.