This is the single most used financial ratio and is an invaluable method for evaluating a company’s success. It is a concise way of presenting the company’s profitability. Earnings per share is the earnings of a company divided by the number of shares of stock outstanding.
By looking at a company’s earnings per share, an investor can clearly see how effective it is at creating earning for individual shareholders. As a company increases the number of shares of stock, the total earnings also increase in response to the additional investment made into the company by more shareholders.
For investors to only concentrate on the total earnings would give the impression the company was doing better than before. However, the basic equation for the earnings per share paints a more authentic picture for the investor.
Earnings per share = earnings
number of shares
The number of shares outstanding can decrease or increase based on several factors:
- Satisfy employee stock options
- Issue or retire shares of stock
- Fulfill obligations to convert bonds
- Combine with other companies
The above equation simplifies things. However, it gets more complicated than that. There are preferred stockholders and common stockholders. When dividends are paid out to preferred stockholders, they must be subtracted from earnings in order to show what is available to common stockholders.
Diluted earnings per share is the most complex equation. Typically, accountants must use reference materials in making these calculations. For a layman, they are much too complex. Perhaps the earnings per share equation is overemphasized by investors. They would be well advised to consider treating the equation like any other ratio when applying their analysis.