How to Compute Earnings per Share Using Financial Statements

No financial metric is more important than earnings per share (EPS). It reveals how much profit (or loss) a corporation earned for a given period, usually a quarter or year, on a share basis. EPS is not only useful on its own as an indication of how well a corporation is operating, but also is used in other important ratios, such as price/earnings (P/E). You use a corporation’s balance sheet and income statement to perform the EPS calculation.

The EPS Formula

EPS represents the theoretical maximum amount of current period earnings that could be distributed as dividends to holders of the corporation’s common stock. Normally, only some of the period’s earnings, if any, are used to pay dividends. Other uses of earnings include boosting retained earnings, buying back outstanding stock, paying down debt and investing in capital projects to grow the company.

The EPS formula contains three terms:

1. Net income for the period: This is the total earnings after subtracting all losses and expenses, including interest charges and taxes. It’s also known as net profit. You can find this number on the income statement.
   
2. Preferred stock dividend: This is the dividend paid to holders of preferred stock. This kind of stock offers high dividends but little price appreciation. The preferred stock dividend appears on the income statement as a subtraction from net income, the difference indicating the earnings available to common shareholders.
   
3. Average common shares per period: The number of shares outstanding can vary for a given period due to shares that are newly issued or repurchased. You can average this number using the number of outstanding common shares from the current and previous balance sheets. Note that some balance sheets list starting and ending shares. If so, you don’t need to refer to the previous balance sheet.
   

The earnings per share formula is:

EPS = (Net income -preferred stock dividends) / Average outstanding common shares

All terms refer to the same reporting period.

Example EPS Calculation

For the year, XYZ Corporation earns $73 million and pays out $13 million in preferred dividends. The number of outstanding common shares at the end of the previous and current periods are 46 million and 50 million, respectively. The EPS for the year is:

EPS = ($73M - $13M) / ((46M + 50M) / 2)

= $60M/48M

= $1.25/share

This example shows trailing EPS, since it uses figures from the previous 12 months. You can also calculate current EPS, using data and projections for the current year, and forward EPS, based solely on projections for future periods. Investors are keenly interested in forward EPS to see whether earnings are expected to grow, stay the same or fall.

Importance of EPS

EPS is significant for several reasons:

• A rising EPS indicates the company is increasing its profits and might decide to hike its dividend.
  
• A falling EPS might be a red flag indicating a loss of profitability, although the loss might be due to an extraordinary event not related to operational profits. A severe EPS drop could cause the corporation to cut or suspend its dividends.
  
• Investors compare the EPS of competitors within the same market segment to see how each company is performing.
  
• Investors check multi-year EPS trends to see if the company has shown steady growth. Such a company is considered a less risky investment than companies with volatile or declining EPS figures.
  
• EPS is used to calculate the price/earnings multiple (P/E), an indicator of how “expensive” the shares are at the current price. P/E is simply EPS divided by the current price of the common stock. A P/E that is high on a historical basis might indicate that the shares are overpriced relative to the risk of a loss.