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To calculate earnings per share (EPS), you need to divide a company’s profits by its common stock’s total outstanding shares. The result offers general insight into the company’s profitability.
In simple words, EPS means how much money a company makes for each share and is primarily used for estimating corporate value. increasing EPS implies the company is becoming more profitable and vice versa.
Here’s how you can calculate the EPS:
Let’s take an example – A company, ABC, reports a net income of $12M and announces $2M in preferred dividends for its fiscal Q1. During the period, the company had 5M (weighted average) outstanding shares.
The EPS of the ABC company as per the formula mentioned above would be
EPS = $ (12M – 2M) / 5M = $2
It is advisable to use a weighted average number of outstanding common stock over the reporting term as the actual number of shares can vary over time.
The EPS metric is one of the most significant variables in shaping a stock price. It is also an important component used for calculating the price to earnings (P/E) valuation ratio. In the P/E ratio, the E stands for EPS. By dividing a company’s stock price by its EPS, you can calculate the share value in terms of how much the market can afford to pay for each earned dollar.
It is essential to judge EPS with respect to the company’s stock price, P/E ratio, or earning’s yield. A low EPS number compared to the last quarter might still lead to a surge in share price if analysts were expecting a worse figure.
Although EPS is a useful financial tool, it still has limitations. Some of them are:
Before selecting any stock for investment, you should also consider other factors such as company stability, relative strength in the industry, debt to equity ratio, and P/E ratio, among others. If the EPS aligns with these factors, you will have a clearer idea of its market performance, profitability, and overall scope.
In these challenging times of lockdown and quarantine, everything around us is at a literal standstill, including our stock market. It’s not a surprise that the Indian markets are currently witnessing massive volatility due to the Covid-19 pandemic. Many of us now wish they had diversified their portfolio, or are looking for efficient ways to diversify it now.
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