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HomeEPS what you need to know to maximize earnings

EPS what you need to know to maximize earnings

EPS stands for Earnings Per Share, and is the amount of money that traders will make per share they own in a business.

Figuring out the EPS is more complex than just looking at the net profits of the company and assuming that means the pay-off for investing might be good. One of the biggest influences on EPS is how many other people own shares in the company; if two companies are earning the same amount of money, they one with less shareholders will have a higher EPS as the money is divided by less people. 

How to calculate & what to keep in mind

Before investing and purchasing shares, traders need to have worked out approximately what the EPS of their investment will be. The most simple way of garnering EPS is that it is the net income divided by the amount of outstanding shares; the outstanding shares being how many shares have been bought. However, there are more accurate ways of deducing what the EPS will be.

The first step is finding out what the shares outstanding is. To do this, you will need a copy of the company’s balance sheet. This is usually included in reports released each quarter. The shareholder’s equity is usually listed at the end of the sheet. Shares outstanding includes items like preferred stock, common stock, and treasury stock if applicable. If there is no treasury stock, the shares outstanding is the sum of the preferred stock and common stock, if treasury stock is present then it needs to be subtracted from the sum.

The figure deduced from the balance sheet can sometimes only be a rough estimate, which us why many traders then find out the weighted average of shares outstanding. The weighted average is calculated by multiplying the amount of shares outstanding with the time period the shares were active in, i.e if the shares were active for six months this is represented as 0.5 and so on and so forth. The sum of shares outstanding from the whole fiscal year is the weighted average.

For example, if a company had 2000 shares outstanding for the first half of the year, and then 1000 for the rest, you do the following:

2000 x 0.5 = 1000

1000 x 0.5 = 500

Weighted average of shares outstanding = 1500

The two main formulas for calculating EPS are as follows:

Net Income ÷ Total Number of Shares Outstanding = Earnings Per Share

Net Income ÷ Weighted Average of Shares Outstanding = Earnings Per Share

However, the second formula is more accurate and therefore more popular.

On the flip side of two companies earning the same amount and having a different EPS, sometimes two companies may have the same EPS as one another but not necessarily earning the same amount of profits. In this case, it’s important to take capital into account as the companies might not have the same equity. When in doubt, the company with a better margins to generate a profit is the one to invest in.

The EPS equations above referred to what’s known as basic EPS. This is the type of EPS traders are usually talking about when they say EPS. Diluted EPS takes stock options, warrants and more into account, while basic EPS does not. These factors could dilute the amount of earnings per share. The diluted EPS is established by dividing the net income with the amount of shares outstanding.

Looking at the past EPS ratio is also helpful for traders considering investing in a company.The previous EPS from previous fiscal years is known as trailing EPS, and can help traders spot trends. If the EPS was steadily increasing every year, traders can hope the current year will do the same.

Traders will also look at the Current EPS, which is an estimate for the current year gathered by using the data to date of the year and the predictions that were made from it. Forward EPS on the other hand, focuses on the EPS projections further into the future. While these types of EPS are largely speculative, and there’s no guarantee they will come to fruition, they help traders made choices about what companies they want to buy shares of. 

Things to be careful of:

Sometimes the EPS is not what it seems, and traders can be misled. 

To avoid falling victim to earnings manipulation, traders should research the earnings report and be critical of the statements they find. It’s also worth looking at a few sources about the financial health of the company and shares rather than taking their own reports or one source at face value.

There is a method of accounting called “Accrual Accounting” that traders need to be wary off. The EPS can be made to look better than it is when accountants write off expenses that have not been paid yet as paid or buying back stocks for more than the company is worth and driving up the stock price.

Although business and trading is always a risk, smart investors will do their best to minimise it as much as possible; after all, their money is on the line. 

How to Increase EPS

The EPS can be increased by the company is that they earn more or if they expand their margin by lowering costs. They can also utilise share buybacks, this means that they lower the number of shares that can be bought without making any alterations to profits. This in turn raises the EPS. Also using the WhatsApp business model will increase the EPS.

How Does WhatsApp Make Money?

The founders of WhatsApp initially did not want to include ads in their messaging service. So if they were opposed to an ad-based service, what was their revenue generation strategy? 

They opted for a ‘freemium’ business model, which means consumers get a great user experience for a small subscription fee. WhatsApp offered a free subscription for the first year, with the expectation that users would pay $0.99 annually afterwards.

Stock splitting as mentioned earlier can dilute the EPS as it means there are more shares, however, stock splitting isn’t always a bad thing. EPS is a useful way for deducing the price-to-earnings ratio (P/E) which is the stock price compared to the amount of EPS. The P/E ratio is the amount of money traders need to pay for their earnings now, and the earnings they could make later on. When the stock splits, the P/E and overall profits and value of the company don’t change. To prove a stock split, investors should refer back to the weighted average equation. Investors should approach a stock split with caution, but don’t necessarily have to run from it. For more information please check out https://www.timothysykes.com/blog/earnings-per-share/

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