Earnings Per Share (EPS) is one of the most widely followed metrics in stock investing. It tells you how much profit a company earns for each share of stock outstanding. Analysts, investors, and the media focus heavily on EPS because it directly affects stock valuations and prices. This guide explains everything you need to know about EPS.
What is Earnings Per Share?
EPS measures a company's profit allocated to each outstanding share of common stock. It is calculated by dividing net income by the number of shares outstanding.
The Formula: EPS = (Net Income - Preferred Dividends) / Weighted Average Shares Outstanding. If a company earns $100 million with 50 million shares, EPS is $2.00.
Basic EPS vs Diluted EPS
Companies report two EPS figures. Understanding the difference is crucial.
Basic EPS
Uses only the current number of shares outstanding. This is the simple calculation.
Diluted EPS
Assumes all convertible securities are converted to common stock. This includes:
- Stock options granted to employees
- Convertible bonds
- Convertible preferred stock
- Warrants
Basic vs Diluted EPS Example
Company XYZ reports:
- Net Income: $100 million
- Basic Shares Outstanding: 50 million
- Employee Stock Options: 5 million shares if exercised
- Basic EPS: $2.00 ($100M / 50M)
- Diluted EPS: $1.82 ($100M / 55M)
Diluted EPS is lower because it accounts for potential share dilution.
Always Use Diluted EPS: Investors should focus on diluted EPS because it represents the worst-case scenario for existing shareholders. A large gap between basic and diluted EPS indicates significant potential dilution.
Why EPS Matters
It Drives Stock Prices
Stock prices are heavily influenced by EPS. When companies beat or miss EPS expectations, stocks often move dramatically. Earnings surprises can cause 5-20% moves in a single day.
It is Used in Valuation
The Price-to-Earnings (P/E) ratio uses EPS in the denominator:
P/E Ratio = Stock Price / EPS
If a stock trades at $50 with EPS of $2.50, the P/E is 20x.
It Enables Comparison
EPS normalizes profit by the number of shares, allowing comparison between companies of different sizes.
EPS Growth: The Key Metric
While absolute EPS matters, EPS growth is often more important for investors.
How to Calculate EPS Growth
EPS Growth Rate = (Current EPS - Previous EPS) / Previous EPS
EPS Growth Example
- Last Year EPS: $2.00
- This Year EPS: $2.40
- EPS Growth: 20% (($2.40 - $2.00) / $2.00)
What is Good EPS Growth?
- Below 5%: Slow growth, typical of mature industries
- 5% to 15%: Moderate growth, healthy for established companies
- 15% to 25%: Strong growth, indicates competitive advantages
- Above 25%: Exceptional growth, often in high-growth sectors
Sources of EPS Growth
EPS can grow through several mechanisms. Some are higher quality than others.
Revenue Growth (Highest Quality)
Selling more products or services grows the top line, which flows to earnings. This is organic, sustainable growth.
Margin Expansion
Improving profitability on existing sales. Good quality but has natural limits.
Share Buybacks
Reducing shares outstanding increases EPS even with flat net income. Moderate quality if bought at reasonable prices.
Buyback Impact on EPS
Company with $100M net income buys back 10% of shares:
- Before: 50M shares, EPS = $2.00
- After: 45M shares, EPS = $2.22
- EPS grew 11% with no change in profit
Acquisitions (Lowest Quality)
Buying other companies can add EPS but may not create real value. Watch for companies that grow mainly through acquisitions.
Quarterly EPS and Earnings Season
Public companies report EPS every quarter. This creates "earnings season" when most companies report within a few weeks.
Analyst Estimates
Wall Street analysts publish EPS estimates. The "consensus estimate" is the average of all analysts covering the stock.
Earnings Surprises
- Beat: Actual EPS higher than consensus (usually positive for stock)
- Miss: Actual EPS lower than consensus (usually negative for stock)
- In Line: Actual EPS matches consensus (neutral)
Guidance
Companies often provide EPS guidance for future quarters. Raised guidance is positive; lowered guidance is negative.
Limitations of EPS
While important, EPS has limitations you should understand:
Does Not Measure Cash
EPS is based on accrual accounting. A company can report strong EPS but have weak cash flow. Always verify with the cash flow statement.
Can Be Manipulated
Management has some discretion over accounting choices that affect EPS. Watch for:
- One-time gains included in results
- Aggressive revenue recognition
- Expense capitalization
Ignores Capital Requirements
EPS does not show how much capital was required to generate those earnings. Two companies with the same EPS might have very different return on equity.
Share Count Games
Companies can boost EPS through buybacks funded by debt, which may not create shareholder value.
Red Flags to Watch For
- EPS growing faster than revenue (margin tricks or buybacks)
- Large gap between basic and diluted EPS (high dilution)
- GAAP EPS much lower than adjusted EPS (questionable adjustments)
- EPS growing while free cash flow declines
- Frequent one-time gains boosting EPS
GAAP vs Non-GAAP EPS
Companies often report both GAAP (standard accounting) and adjusted (non-GAAP) EPS:
GAAP EPS
Follows standard accounting rules. Required by regulators. Includes all gains and losses.
Adjusted (Non-GAAP) EPS
Excludes items management considers non-recurring:
- Restructuring charges
- Stock-based compensation
- Acquisition-related costs
- Legal settlements
Adjusted EPS can provide insight into ongoing operations but can also be used to hide problems. Always compare both figures.
How to Analyze EPS
Step 1: Look at the Trend
Track EPS over 5 to 10 years. Is it growing consistently? What is the compound annual growth rate?
Step 2: Understand the Drivers
Is EPS growth coming from revenue, margins, or buybacks? Revenue-driven growth is most sustainable.
Step 3: Compare to Peers
How does EPS growth compare to competitors? Industry leaders often have superior EPS growth.
Step 4: Check EPS Quality
Compare EPS to cash flow per share. They should move together over time.
Step 5: Consider Valuation
Combine EPS with the P/E ratio. High EPS growth with low P/E may indicate undervaluation.
Track Earnings Performance
Pro Trader Dashboard helps you monitor EPS trends, growth rates, and earnings surprises across your portfolio. Stay informed about the companies you own.
Summary
Earnings Per Share measures profit allocated to each share of stock. Focus on diluted EPS for conservative analysis. EPS growth is crucial for stock appreciation, but understand what drives it. Revenue-driven growth is highest quality. Watch for manipulation and always verify EPS with cash flow. EPS is essential for valuation but should be used alongside other metrics for complete analysis.
Ready to learn more? Check out our guide on profit margin analysis or learn about return on equity.