Earnings per share (EPS) refers to amount of a company’s profit associated tied to each outstanding share in the stock market. It is calculated by taking a company’s net income, subtracting preferred dividends, and dividing the difference by the number of shares, or:
EPS = (Net Income – Preferred Dividends) / Average number of shares
For example, Smith Hardware’s net income for the quarter was $720,000 and it paid $20,000 in preferred dividends. If the average number of outstanding shares was 100,000, then EPS would be $7.00. Usually the number of outstanding shares is determined as a weighted average over the given time period since the number of shares can vary.
EPS is a key variable used in determining a share’s price. It is also used to calculate price-to-earnings valuation ratios that allow investors to compare different companies in the same industry. When looking at EPS, it is important to also take into account how much capital went into making those earnings. If two companies have a similar EPS, but one invested less equity, than that company is likely making more efficient use of its capital and is in healthier condition.