Hello! This is Good Morning USA, walking the path of investment together with you. Do you remember when we learned about PER (Price-to-Earnings Ratio) last time? PER helps determine if a company's stock price is appropriate compared to the profit it earns. The key element in the denominator of this PER calculation is EPS (Earnings Per Share), which we will discuss today.
EPS is one of the most direct indicators of a company's profitability, and it is an essential concept that every investor must understand. Today, we will explain what EPS is, how it is calculated and interpreted, and how it can be used in investment decisions in an easy and clear way.
What is EPS (Earnings Per Share)?
EPS, or Earnings Per Share, is literally the net income (profit for the period) that a company earns divided by the total number of outstanding common shares issued by that company. More precisely, it is the net income minus preferred dividends, divided by the number of common shares.
In simple terms, it shows "how much profit has been generated per share?" From an investor's perspective, it is an important 'report card' that tells you how much profit one share you own is bringing to the company.
How is EPS Calculated?
The formula for calculating EPS is as follows:
EPS = (Net Income - Preferred Dividends) / Weighted Average Number of Outstanding Common Shares
Let's take a closer look at each item:
Net Income: This is the pure profit remaining after deducting all expenses such as cost of goods sold, selling and administrative expenses, non-operating expenses, and corporate tax from the total revenue earned by the company during a certain period (usually 1 year or a quarter). It can be said to be the company's final profit performance.
Preferred Dividends: Among the shares issued by a company, there may be preferred shares in addition to common shares. Preferred shareholders often have the right to receive dividends before common shareholders. Therefore, preferred dividends are deducted from the net income first to accurately calculate the portion going to common shareholders.
Weighted Average Number of Outstanding Common Shares: This is the average value of the number of common shares traded in the market during the calculation period, taking the period into account. The number of outstanding shares continues to fluctuate due to paid-in capital increases, free stock dividends, and treasury stock purchases/cancellations. Therefore, using the weighted average that reflects the changes throughout the period, rather than the number of shares at a specific point in time, will give a more accurate EPS. (Generally, investors can check the EPS value disclosed in the financial statements.)
Why is EPS Important?
EPS has the following important meanings for investors:
Key Indicator of Profitability Measurement: It shows most directly how efficiently a company is making profits. The higher the EPS, the greater the profit returned to shareholders.
Judgment of Company Growth: If the EPS has shown a steadily increasing trend from the past to the present, it is an important basis for judging that the company's profit-generating ability is improving and growing.
Basis of Valuation: It is an essential element in calculating PER (= Stock Price/EPS) that we learned last time. The higher the EPS, the lower the PER, which can increase the valuation attractiveness of the company.
Easy Comparison Between Companies: It is useful for evaluating relative profitability by comparing EPS with competing companies in the same industry.
Basic EPS vs. Diluted EPS, What's the Difference?
In a company's financial statements, you often see both 'Basic Earnings Per Share (Basic EPS)' and 'Diluted Earnings Per Share (Diluted EPS)'.
Basic EPS: This is the EPS calculated based only on the number of common shares currently in circulation.
Diluted EPS: This is the EPS calculated by considering not only the number of shares currently in circulation, but also potential shares (convertible bonds, bonds with warrants, stock options, etc.) that can be converted into common shares in the future. If all these potential shares are converted into common shares, the total number of shares will increase, and the profit (EPS) per share will decrease. Diluted EPS can be said to be a conservative view of EPS that assumes this worst-case scenario. Therefore, investors generally tend to refer to Diluted EPS more importantly to evaluate a company's profitability more strictly.
How to Interpret and Utilize EPS?
The Higher, the Better (Generally): A high EPS means that the company's profit-generating ability is excellent.
Trend is More Important: It is much more important to see a trend of steadily increasing EPS from the past to the present than the EPS value at a single point in time. This is a strong signal that the company is continuously growing.
Compare with Expectations: It is important to compare the actual EPS announced with the EPS estimates (consensus) announced by securities companies for that company. If the actual EPS significantly exceeds the estimates, it can have a positive impact on the stock price as an 'Earnings Surprise', and conversely, if it significantly falls short, it can have a negative impact as an 'Earnings Shock'.
Points to Note When Using EPS!
EPS is not an omnipotent indicator. You should be aware of the following points when interpreting it:
Influence of Accounting Treatment Methods: Net income may vary depending on accounting treatment methods such as changes in depreciation methods, which also affects the EPS value.
Filtering One-Time Factors: If net income fluctuates significantly due to non-recurring (one-time) factors such as gains from asset sales or restructuring costs, EPS may be distorted. It is important to judge based on profits generated from sustainable business activities.
Effect of Treasury Stock Purchases: If a company purchases and cancels treasury stock, the number of outstanding shares decreases, so EPS may increase even if profits remain the same or even decrease. You need to distinguish whether this is actual profit growth or due to financial techniques.
View with Other Indicators: EPS shows profitability, but it does not show the overall financial soundness of a company, such as its debt level, cash flow, and asset status. It is essential to analyze it comprehensively with other financial indicators.
Closing Remarks
EPS is a powerful and essential indicator that clearly shows a company's profit-generating ability. Accurately understanding the meaning and calculation method of EPS, the difference between Basic/Diluted EPS, and the precautions when interpreting it is the basis for successful investment.
However, do not try to judge everything with just EPS, and I hope you become a wise investor who looks at other financial indicators comprehensively along with a steady growth trend.
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