EPS - Why Is It So Critical In Understanding What It Means
January 4th, 2008 by admin
EPS is an acronym for Earnings per share. Stock markets such as NYSE and NASDAQ have thousands of listed public companies. Investors such as Institutions, Banks, Mutual funds and Individuals invest in these companies by purchasing shares in these companies. A share can be explained as a unit of ownership. Public companies raise capital for their business by issuing shares. Earnings of these companies is a key statistic that every investor and owner wants to know about. Since there is a myriad of companies across a broad spectrum of industries, investors need a common measure for understanding earnings in the companies that they invest in. Enter EPS.
Earnings per share is the earning that a company has generated in a specific period, usually annually, spread among all the shares that are issued. Let us illustrate this by a simple example. Assume that Company X earned $5M in 2007. Also assume that the company has issued and outstanding one million shares. Divide $5M million by 1 Million shares to arrive at an earnings per share of $5. The numerator is income available for distribution among shareholders. This equals net income reduced by any dividends paid to the preferred stockholders. Some corporations issue preferred stock that require a fixed amount of dividends to be paid every year. Also, technically speaking the number of shares could be a weighted average as companies issue stock options etc. Sometimes corporations issue convertible securities too. To warn all investors of the potential dilution if all stock options were exercised and/or convertible securities are converted.
Expectations of this statistic should however, be tempered by its limitations. Comparisons should be made of this statistic by each industry, size of the business, years in business and a host of other comparisons. This statistic, both basic and diluted needs to be reported in the income statement of public corporations. This indicates its importance.
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