The Advantages of Earnings Per Common Shares

Earnings per common share is a financial ratio, and it's usually the first ratio investors look at when analyzing a stock. Despite its simplicity, this metric is extremely powerful and condenses a great deal of crucial information into a single number. It allows investors to compare alternative investments, chart the performance of a particular business over time and estimate the growth of her investments in the future.

Definition

Earnings per common share is the total earnings of a company that belong to common shareholders, divided by the number of common shares outstanding. To calculate this number, first determine the number of preferred shares and dividends payable to them. Preferred shares are a special share class, entitled to a fixed annual dividend. By multiplying the number of preferred shares with the dividend payable to each of them and subtracting the resulting figure from the company's net earnings, you find the portion of the company's profits that belong to common shareholders. Divide this number by the number of common shares to calculate earnings per common share.

Calculating Your Income

The chief advantage of earnings per common share is that it allows you to easily calculate how much the company earned on your behalf. Multiply the earnings per common share by the number of stocks you own to calculate your claim on the business's net income. By doing this for all companies in your portfolio, you can compare how much each of them profited on your behalf. Because earnings per common share quantifies per-share income, it makes other measures irrelevant, including the size of the business, number of common shares outstanding and other instruments issued by the company, such as bonds and preferred stocks. This allows for an apples to apples comparison.

Time Series

Earnings per common share also makes charting the performance of management over time easy, because it eliminates such confounding variables as new products the company may have launched or assumptions of bank loans. If the company is earning more per common share than last year, it is probably doing a better job. One caveat: Stocks can "split," meaning the company can collect outstanding shares and replace each old share with several new ones, effectively splitting each old share. When this happens, you must carry out additional calculations to meaningfully compare old and new earnings per common share figures.

Earnings vs. Dvidends

Even though those earnings belong to you, how they will be used is up to the company's board of directors. The board will decide whether some or all of these earnings are to be paid to shareholders in the form of dividends or reinvested into the business. Over the long term, the money will end up in the hands of shareholders, so earnings per common share is a good indication of your long-term income. To calculate your short-term cash income, however, use the dividend per share figure announced by the board.