Earnings per share is a financial metric that represents the portion of a company’s profit allocated to each outstanding share of common stock.
Understanding earnings per share
Earnings per share indicates how much money a company makes for each share of its stock. The standard calculation involves subtracting preferred dividends from a company’s net income and dividing that result by the average number of outstanding shares over a specific reporting period. A higher number indicates greater profitability on a per-share basis.
Financial statements usually present two variations of this figure. Basic earnings per share uses only the currently outstanding common shares. Diluted earnings per share expands the share count to include convertible securities and unexercised stock options that could potentially become common shares. Diluted earnings per share is always lower than or equal to the basic calculation, offering a more conservative view of profitability.
Market participants use this figure to evaluate financial health and to compare a business to its competitors. It is the primary input for the price-to-earnings ratio, a valuation method that compares a stock’s market price to its generated profits. Publicly traded companies report these figures on quarterly and annual schedules.
The metric has limitations that require attention. Company management can increase earnings per share by repurchasing stock, which reduces the total number of outstanding shares without actually improving business operations. It also ignores the capital required to generate the earnings and the total debt load the company carries. Fellow Elephants should review earnings per share alongside cash flow statements and balance sheets to understand a company’s complete financial situation.
Example
Consider a fictional business called Trunk Logistics, a heavy freight company moving agricultural goods across the savannah. In the most recent fiscal year, Trunk Logistics reported a net income of 500,000. The company paid 50,000 in dividends to its preferred shareholders. This leaves 450,000 in net profit available to the common shareholders.
During that same year, Trunk Logistics had 100,000 shares of common stock outstanding, which are owned by various elephants in the local herd. To find the earnings per share, divide the 450,000 available profit by the 100,000 outstanding shares. The calculation results in 4.50. This means that for every single share an elephant holds in Trunk Logistics, the company generated 4.50 in profit over the course of the year.