Calculating EPS: A Comprehensive Guide for Investors

This comprehensive guide explores how to calculate EPS, the importance of EPS in stock valuation, common mistakes to avoid, top industries with high EPS, and how to calculate EPS for new and growing companies. By using EPS and other financial metrics, investors can make informed investment decisions that align with their investment goals.

I. Introduction

As an investor, understanding the financial health of companies is essential. One of the most critical metrics investors use to make informed decisions is Earnings per Share (EPS). EPS is a critical measure that shows the amount of profit earned by each share of a company’s common stock. This article provides an in-depth guide to how to calculate EPS, the importance of EPS in stock valuation, common mistakes to avoid, top industries with high EPS, and how to calculate EPS for new and growing companies.

II. A Step-by-Step Guide to Calculating EPS

EPS is a financial metric that measures the profitability of shares in a company. The formula to calculate EPS is the company’s net income divided by its total outstanding shares. The following steps will guide you on how to calculate EPS:

Determine the company’s net income from its income statement, which will be at the bottom of the statement after operating expenses, depreciation, taxes, and interest have been deducted.
Determine the number of common shares outstanding by checking the balance sheet. The value is usually stated on the balance sheet under the shareholder’s equity.
Divide the company’s net income by the total number of common shares outstanding. EPS formula: EPS = (Net Income / Total Outstanding Shares).

For example, if a company’s net income is $1,000,000, and it has 500,000 common shares outstanding, the EPS would be $2.00. (EPS = $1,000,000 / 500,000 shares).

III. Common Mistakes to Avoid When Calculating EPS

Though calculating EPS is relatively straightforward, some common mistakes could lead to inaccurate calculations. Here are some of the common mistakes you should avoid when calculating EPS:

Mistakenly including preferred shares when calculating total outstanding shares
Using a net income figure from a different period for EPS calculation
Using a diluted outstanding shares figure
Using a weighted average of shares outstanding figure

Inaccurate EPS figures can mislead investors when making investment decisions. Therefore, it’s essential to ensure that you avoid these common mistakes. To avoid these mistakes, you should always double-check your calculations and ensure that you are using correct figures.

IV. Understanding the Importance of EPS in Stock Valuation

EPS is used to value the common shares of a company in the stock market. It’s the principal metric that shows a company’s earnings performance, indicating the company’s growth potential. Investors use EPS to determine the value of a company’s shares and compare it with similar industry peers. A company with a high EPS ratio is considered to be financially healthy and has higher growth potential, while a low EPS ratio is considered a red flag.

EPS is also used to calculate the Price to Earnings Ratio (P/E Ratio), which is a widely used valuation metric that investors use to determine whether a stock is overvalued or undervalued. The formula to calculate P/E ratio is Stock Price / EPS. A high P/E ratio indicates that investors have high hopes for the future profitability of the company.

In addition to EPS, other critical financial metrics that investors use to value stocks include Price to Sales Ratio (P/S Ratio), Price to Earnings Growth Ratio (PEG Ratio), and Debt to Equity Ratio. P/S ratio is used to evaluate a company’s revenue, while PEG ratio is used to calculate a company’s growth potential relative to its current stock price. Debt to equity ratio is used to evaluate a company’s debt management.

V. Top Industries with Highest EPS

Some industries are known to have high EPS ratios, indicating their high profitability and growth potential. Here are some of the top industries with high EPS:

Tech Industries – Technology companies tend to have high EPS ratios due to their rapid growth, innovation, and high-profit margins. For example, Apple has an EPS of $3.28, and Google’s EPS is $22.30.
Pharmaceutical Industries – Due to their high research and development (R&D) costs and patent protection, Pharmaceutical companies tend to have high EPS. For example, Pfizer has an EPS of $2.13, and Eli Lilly’s EPS is $5.22.
Financial Services – Banks and other financial services companies have high EPS due to their high-profit margins and low overhead costs. For example, J.P Morgan has an EPS of $11.95, and Wells Fargo’s EPS is $4.92.

VI. Calculating EPS for New and Growing Companies

For new and growing companies, EPS may not be the best metric to use since the company may not yet be profitable. In such cases, other metrics must be used to evaluate their financial performance, such as:

Price to Sales Ratio (P/S Ratio) – This ratio is calculated by dividing the stock price by the company’s annual revenue per share. This ratio is useful for companies that are not yet profitable, and investors use this ratio to evaluate a company’s future profitability.
Debt to Equity Ratio – This metric is used to evaluate a company’s leverage. A low debt to equity ratio indicates that the company is using less debt to finance growth, which is advantageous for investors.
Current Ratio – This metric is used to evaluate a company’s liquidity by dividing current assets by current liabilities. A company with a high current ratio is considered to be financially healthy.

For example, Amazon’s EPS was negative for several years due to its focus on growth and reinvestment into its business. However, investors still valued the company by using other metrics such as P/S Ratio and growth projections.

VII. Conclusion

EPS is a critical metric that investors use to make informed decisions about investing in a company’s stock. Calculating EPS requires knowing a company’s net income and the total number of common shares outstanding. It’s important to avoid common mistakes such as using diluted outstanding shares or net income from the wrong period. EPS is used to value a company’s shares in the stock market and is used with other metrics such as P/S ratio, P/E ratio, PEG ratio, and debt to equity ratio. High EPS industries include technology, pharmaceutical, and financial services. For new and growing companies, other metrics such as P/S ratio, current ratio, and debt to equity ratio must be used to evaluate their financial performance. By using EPS and other financial metrics, investors can make informed investment decisions that align with their investment goals.