We recently talked about market capitalisation in our article on Apple becoming a 2 trillion dollar company. Market capitalisation is one, fairly crude, way of measuring the value of a company but there are loads more out there and understanding them is the key to understanding how market traders make their buying and selling decisions.
One of these other valuation methods is earnings-per-share, usually referred to just as EPS. The basics of EPS are easy to understand:
To calculate the earnings-per-share (EPS) for a company just divide the company’s net profit by the number of shares available to the market (shares outstanding).
Example: A company has a net profit for the year 2019 of $6 billion. During 2019 the average number of shares the company had outstanding was 4 billion, giving an EPS of $1.50:
$6 billion ÷ 4 billion = $1.50
So, EPS tells you how much profit a company makes per share.
Is it really that simple?
Like many things in the world of finance, although EPS seems really simple at first glance there are a number of ‘gotchas’ that you need to be aware of. We’ll look at some of these in more detail in later articles but this is what they boil down to:
- The number of shares outstanding can change. Companies can issue more shares, buy up existing shares, carry out splits, etc. and investors can exercise stock options – all of these change the number of shares outstanding. You need to take account of this when calculating EPS for a given period.
- There are different way to measure net profit. For example, it’s normal to subtract the total amount of ‘preferred dividends’ from the company’s net income when calculating EPS. Companies also usually exclude ‘extraordinary items’ from their net profit when calculating EPS. These might be extraordinary profits (for example from selling off assets) or extraordinary losses (for example paying out compensation for an oil spill).
- Different companies operate differently, especially in different sectors. This means that comparing EPS across companies is not always meaningful. For example, at time of writing Uber has never made a profit yet plenty of people think it’s a good investment.