Earnings per share (EPS) is important data in fundamental analysis that shows the profits attributable to investors or a company’s shareholders.
In addition to revenue, EPS is one of the most closely-followed data whenever a company publishes its results. And, as we have repeatedly said, earning seasons are one of the times when traders with a good strategy can maximize their profits.
In this article, we will look at what Earning per Share is, how it is calculated, and how you can use it in the market as a day trader.
What is the EPS?
A company has three key documents that traders pay close attention to. It has an income statement that shows the company’s income and expenses. This statement is the one that shows the amount of revenue a company made and how it spent it. It was previously known as a profit and loss statement.
The second document is known as a balance sheet. It is the one that describes the financial standing of a company. It shows the company’s assets and liabilities. Finally, there is the cash flow statement, which shows how money is flowing in a company.
The EPS falls into the income statement.
While a company’s shareholders love the net income, they mostly focus on the amount that is attributed to them. For example, if a company generates a profit of $10 million, this amount will matter depending on the number of outstanding shares.
Therefore, the EPS provides an answer to the overall income weighted against the number of outstanding shares.
How the EPS is calculated
There are three main things to consider when thinking about Earning per Share. First, there is the overall profitability of a company. In this case, this is known as the net income (revenue minus all costs).
Second, there is preferred payments. These are payments that a company makes to its preferred investors. And finally, there is outstanding shares. Outstanding shares refers to all publicly traded shares of a company.
Therefore, to calculate this number, you need to follow the following steps.
- Find a company’s net income.
- Assess whether it has made any preferred payments or dividends.
- Divide the results with the number of outstanding shares.
For example, assume that a company made $50 million in net income in a quarter. At the same time, the firm paid $5 million to preferred shareholders. And assume that the firm has 200,000 outstanding shares. In this case, the EPS will be:
| ($50,000,000 – $5,000,000) / 200,000 = $225 |
Real example of Earning per Share
In the third quarter of 2021, PayPal made a revenue of more than $10.8 billion. Excluding all expenses, the company’s net income was $1.4 billion. The company did not make any payments to shareholders. At the same time, the firm has 1.175 billion outstanding shares.
Therefore, in this case, the company’s earnings per share is $1.19. This figure was calculated by dividing $1.4 billion and 1.175 billion.
Types of EPS
There are several types of Earning per Share that you will encounter with. Let us look at some of them.
- Basic EPS– The most generic ones and is the one that we have identified above. It is simply calculated by dividing income and outstanding shares.
- Diluted EPS – This is a type of EPS that shows the quality of a company’s earnings. It looks at the overall value per share if all convertible securities were exercised. It is calculated using the formula below.
| Diluted EPS = (Net income – preferred dividends) / WASO + CDS |
In this case, WASO is the weighted average shares outstanding while CDS is the conversion of dilutive securities.
- Normalized basic EPS – The normalized earning per share is one calculated to reflect the adjustments made to the income statement. Some of these normalized items in an income statement are one-off costs, non-recurring gains or losses, and discretionary expenses.
- Forward EPS – This is an EPS that is calculated using estimates of a company’s future earnings.
EPS for day trading
So, with this in mind, how can use EPS for day trading? The correct answer to this is that you can use this number for day trading in a very limited way. Indeed, most traders look at EPS of a company only during earnings season.
The reason for this is relatively simple. Day traders are rarely focused on a company’s fundamentals. They are not interested in things like revenue growth and even profitability. Instead, they are usually focused on the performance of charts.
EPS and other information found in the income statement, balance sheet, and cash flow statement are only useful to investors. These are people who buy and hold stocks for a long time. They look at the EPS in a bid to understand the overall health of the company. Also, they want to understand whether a company’s EPS is growing or not.
Also, many growth investors rarely look at the earning per share because most growth stocks are usually not profitable companies.
As stated, as a trader, the only time when you will use a company’s EPS is during the earnings season. An earnings season is a period when a company is publishing its results.
Ideally, when this happens, the market usually focuses on whether a company has beat or missed revenue and EPS. In theory, shares of a compay will rise when it publishes strong EPS and guidance.
Relation between EPS and PE ratio
In a fundamental analysis for stocks, one of the closest-watched valuation metric is known as the PE ratio. It is the most commonly-used multiple in valuations. A PE ratio refers to a company’s share price and its relationship with its earnings. It is calculated using the following formula.
| PE ratio = Share price / EPS |
For example, if a stock is trading at $20 and the company has an EPS of 2, it means that its PE ratio is 10.
Summary
In this article, we have looked at what earnings per share is and how it is calculated. We have also looked at the various types of EPS and how traders and investors use it.
Again, these numbers are not very relevant to day traders, or at least they are for a very limited period of time (that of earnings).
External useful Resources
- Why The EPS Rating Is One Key To Picking The Best Stocks – Investors.com
