Earnings Per Share (EPS) Definition: Day Trading Terminology
Earnings Per Share (EPS) can be defined as a portion of a company’s profit allocated to a person’s share of the stock. It is also the market prospect ratio used to measure the net income earned per share of stock outstanding and helps to show how profitable a company has become especially on the shareholder’s basis.
As an important variable, it is used to determine a share’s price which in turn is utilized to calculate the price-to-earnings valuation ratio. To understand valuation, it is the process whereby the current worth of an asset or company is determined. There are so many techniques used to value a company and some of them include looking at the company management, the capital structure, future earnings and market value of assets.
Back to EPS; it is an important financial measure to investors and traders. When it comes to calculating EPS, the weighted ratio should be used. This is because the number of shares outstanding is known to change with time.
How to calculate EPS
As said earlier, weighted average number of shares outstanding is the best variable to use and not the number of shares. It is common to find data sources simplifying the calculation by using number of shares outstanding at a particular period.
The general formula used to calculate EPS is
Net Income – Dividends on Preferred stock/Average Outstanding Shares.
Here is a simple example to better understand EPS. Let’s assume you have a company trading as A. This company has a net income of $4 million in a single year. Assume the company was to pay out to its shareholders $750,000 in preferred dividends. It has 1 million shares for half of the year and the other half is 1.5 million shares. The EPS would amount to 1.63. So how did this amount come about?
First and most, you need to identify your variables and they include:
a. Net income – $ 4 million
b. Dividends on preferred stock – $750,000
c. Average outstanding stock = weighted average.
To calculate the weighted average you need to multiply the 1 million shares by 0.5 and the 1.5 million shares by 0.5. The resulting values should be added together giving you the Average outstanding shares.
Types of Earnings Per Share
There are 5 types and they include:
This refers to the basis for measuring earnings per share where it accounts for profits and losses from operation, trading and interest activities. It covers those that have been discontinued or acquired at any point during the year. As a stringent measuring tool, it is used by investors to compare and contrast different companies according to methods of accounting for net income.
2. Pro forma
The word is derived from the Latin term “pro forma” meaning “for the sake of form”. It also means “as a matter of form.” In the investment world, pro forma is a method used to calculate financial results. It emphasizes on present and projected figures.
3. Cash Earnings per share
This is a measure of financial performance formulated by a company on per share basis. Cash EPS is different from basic EPS because it concentrates on net income of the company on per share basis. It is more important than other EPS values because it is said to be pure. Cash EPS is also better since the operating cash flow can never be manipulated easily when compared to net income.
4. Ongoing Earning per share
This value is calculated based upon ongoing net income. This type of earning per share does not exclude anything. The purpose of Ongoing EPS is to locate the stream of earnings from the company’s core operation. This is used to forecast future EPS values.
5. Reported EPS
It refers to the number achieved from generally accepted accounting principles. This value is usually reported to the SEC during filling. For a company to derive this value, accounting guidelines need to be followed. It is important for investors to read the footnotes to know which factors should be added in normal earnings and where to make adjustments in their calculations.
For investors who are interested in a steady stream of income, the EPS value is the best way to determine if there is room for increasing the existing dividend. Earnings Per Share is an important tool for investors as well as traders. It should always be considered allowing investors and traders to make informed investment decisions.