What is EPS in stocks? Earnings per share, why it’s important, how it's used

The dates when companies release earnings are key for traders and investors. Performance over the past quarter and guidance for the year influence the share price by changing investors’ expectations.

EPS or earnings per share helps to capture the results in a single number.

In this post, we’ll explain what is meant by EPS, one of the most important financial metrics.

What is earnings per share?

Without going into accounting definitions, the company’s ‘earnings’ are simply profits (i.e. revenue minus costs).

Earnings per share are exactly that: earnings divided by the number of shares. EPS answers a simple question: “how much profit is made for each share?”

Why is this important?

A consistently growing EPS implies that the company is creating value for investors. Similarly, a declining EPS might signal problems. That’s why it’s the headline number for financial journalists. It’s also a key output for Wall Street analysts who prepare their estimates ahead of every earnings release. The average of these estimates is known as consensus estimate.

How EPS is calculated

The general EPS formula is simple. Earnings per share is calculated by dividing the profit (also known as net income) by the number of shares.

The number of shares outstanding simply means the stock held by all parties, including investors and company executives (you can find this on the company's balance sheet).

There are slight variations in the way EPS equation is applied by different organisations or under different accounting standards, but this is largely irrelevant for you – you don’t have to calculate it yourself.

How is earnings per share used

EPS is an important barometer that shows investors how the company is doing.

Reacting to “missed earnings” and “beating estimates”

You might have heard these cliches in the media. If a company has “beaten” or “exceeded” the estimate, that means the reported figures have exceeded the Wall Street analyst consensus. Similarly, if a company has “missed” earnings, that's because the reported figure came below what was expected.

• If the overperformance was a surprise, the share price is likely to go up after the earnings announcement;
• If the underperformance was a surprise, the share price is likely to go down;
• It might also be the case that the market has priced in the discrepancy between the estimate and the released figure – the price somehow reflected the information and hence will not change.

Calculating PE ratio

If you know the EPS, you can also calculate another important metric: the price / earnings ratio. Simply divide the share price by the EPS.

This PE ratio lets you quickly compare different companies or even different industries:

• Fast-growing companies and industries have high PE ratios as investors anticipate that more profits will come in future;
• Stable companies have lower PE ratios – investors assume that profits will remain the same;
• Declining industries show even lower PE because investors expect that things will only get worse.

Factors Affecting EPS 

The Earnings Per Share (EPS) of a company is influenced by a variety of factors, both internal and external. Understanding these factors is crucial for investors to evaluate how a company's profitability might evolve over time. Below is a detailed breakdown of the major elements that impact EPS.

1. Revenue Growth: The Foundation of Higher EPS

Revenue growth is one of the most direct drivers of EPS. Companies that increase their revenues often see a corresponding rise in net income, which directly feeds into the EPS calculation.

When a company generates higher revenue, it usually results in higher profits (assuming costs remain controlled). This increase in net income raises the numerator in the earnings per share formula, boosting the EPS.

Key Drivers of Revenue Growth:

• Expanding market share
• Launching new products or services
• Entering new markets
• Increasing prices for products or services

2. Operating Expenses: The Cost Control Factor

Operating expenses, which include costs such as salaries, rent, utilities, and raw materials, play a significant role in determining a company's profitability and, consequently, its EPS.

How Reducing Operating Expenses Improves EPS:

When a company manages to lower its operating costs while maintaining or increasing revenue, it enhances its profit margins. This leads to a higher net income, positively impacting EPS.

Strategies to Control Operating Expenses:

• Implementing efficient production processes
• Negotiating better supplier contracts
• Outsourcing non-core activities
• Reducing unnecessary administrative overhead

Stock Buybacks: Boosting EPS by Reducing Share Count

Stock buybacks, also known as share repurchases, occur when a company buys back its own shares from the open market. This reduces the number of outstanding shares, which is the denominator in the EPS formula.

How Stock Buybacks Increase EPS:

By reducing the number of shares outstanding, even if net income remains unchanged, the EPS will increase because fewer shares now represent the same earnings.

Reasons for Stock Buybacks:

• To return excess cash to shareholders
• To signal confidence in the company's future
• To improve financial ratios, including EPS and P/E

Potential Downsides of Stock Buybacks:

• Overpaying for shares in the market can reduce overall shareholder value.
• Excessive buybacks can limit funds available for investments or debt repayment.

4. Dividend Payments to Preferred Shareholders

Although not directly a factor in revenue or expense management, dividend payments to preferred shareholders can affect EPS. Since preferred dividends are subtracted from net income in the EPS formula, higher dividend payments reduce the profits available to common shareholders.

Impact on EPS:

An increase in preferred dividend payments lowers the net income available for calculating EPS, which can reduce the value of EPS for common shareholders.

5. External Factors and Market Conditions

While internal factors like revenue growth and cost control are critical, external conditions also influence EPS indirectly.

• Economic Conditions. A strong economy can boost consumer spending, increasing company revenues, while a weak economy might lead to lower demand and declining EPS.
• Regulatory Changes. New regulations can increase compliance costs, reducing net income and potentially lowering EPS.
• Currency Exchange Rates. For multinational companies, fluctuations in foreign exchange rates can impact revenues and expenses, affecting EPS.
• Competition. Intense competition might force a company to lower prices, reducing profit margins and EPS.

Forecasting EPS

Wall Street analysts estimate earnings per share by building financial models that try to predict the income statement of the company. To do that, they are relying on past financial statements and additional data sources, such as competitors’ statements, market reports, industry news, consumer trends, and other fundamentals.

It’s important to remember that EPS does not depend on the current share price, so technical analysis won’t help here. You should look at the industry, the company’s fundamentals, its peers, and the wider picture in the news.

Adjusting EPS

Because earnings per share is so important for the markets, corporations might try to manipulate their EPS. In other cases, some events distort earnings, making it look to high or low. That's why analysts some times make adjustments to EPS.

• Earnings per share excluding extraordinary items. If a company received a huge penalty it would make a temporary dent in profit, leading to a temporarily lower EPS. Similarly, if a company sold its office building at a profit, this would boost its earnings per share. These events are 'extraordinary', i.e. they don't happen every year. So analysts would exclude them from calculating the company's earnings if look at the longer term.
• Earnings Per Share from Continuing Operations. If a company sold some of its profit-generating assets, then net income would be lower in future. When calculating earnings per share, analysts might exclude profit contribution from businesses that are sold or shut down.

Basic EPS vs Diluted EPS

You might also come across the term "diluted EPS". That's the earnings per share that would result if the number of shares increases because all options are exercised, convertible bonds are turned into common shares, and so forth. Of course, diluted EPS would always be lower than basic EPS that we reviewed above.

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