Earnings Per Share (EPS)

Definition

Earnings per share (EPS) is a financial metric that indicates the portion of a company's profit allocated to each outstanding share of common stock. It serves as a key indicator of a company’s profitability and is often used by investors to assess financial health and compare performance across companies. EPS can be affected by factors such as stock issuance, repurchase activities, and overall earnings, making it essential for understanding how shareholder equity is impacted by these corporate actions.

5 Must Know Facts For Your Next Test

1. EPS is calculated by dividing net income by the weighted average number of outstanding shares of common stock during the period.
2. When a company issues new stock, it can dilute existing shareholders' EPS, as the same amount of earnings is spread over a larger number of shares.
3. Stock repurchases can increase EPS because they reduce the number of shares outstanding, allowing remaining shares to represent a larger share of earnings.
4. There are two main types of EPS: basic EPS and diluted EPS; diluted EPS accounts for potential shares that could be created from securities like stock options.
5. Investors often look at EPS trends over time and compare them to other companies in the same industry to evaluate growth potential and investment opportunities.

Review Questions

• How does the issuance of new stock impact a company's earnings per share (EPS)?
  • When a company issues new stock, the total number of outstanding shares increases. This means that the company's earnings are distributed over a larger pool of shares, which can lead to a decrease in EPS if net income remains constant. Therefore, while issuing stock can provide capital for growth, it can also dilute existing shareholders' ownership and reduce their proportional claim on earnings.
• What are the implications of stock repurchase programs on earnings per share (EPS) calculations?
  • Stock repurchase programs have a direct positive effect on earnings per share (EPS) calculations. When a company buys back its own shares, it reduces the number of shares outstanding. This reduction allows the remaining shares to claim a larger portion of the company's earnings, often leading to an increase in EPS. Investors may view this positively as it suggests that the company believes its stock is undervalued and is committed to enhancing shareholder value.
• Evaluate how both issuance and repurchase of stock affect investor perceptions of earnings per share (EPS) and overall company performance.
  • The issuance of new stock can lead to skepticism among investors regarding a company's growth strategy if it dilutes EPS without a corresponding increase in net income. Conversely, stock repurchases typically signal management's confidence in the company's financial health and future prospects. As repurchases enhance EPS by reducing outstanding shares, they can foster positive investor sentiment. Thus, the balance between issuing and repurchasing shares plays a crucial role in shaping investor perceptions about profitability and the effectiveness of management strategies.

Related terms

Net Income: Net income is the total profit of a company after all expenses, taxes, and costs have been subtracted from total revenue, forming the basis for calculating EPS.

Diluted Earnings Per Share: Diluted earnings per share accounts for all potential shares that could be created from convertible securities, stock options, or warrants, providing a more conservative view of EPS.

Dividends: Dividends are payments made by a corporation to its shareholders, often derived from net income, impacting the retained earnings portion considered when calculating EPS.