However, some companies can either invest their equity back into their company or pass it on to the shareholders with dividends. This resulted in plummeting stock prices for these dot-com companies.ĮPS is used to calculate performance but when the company makes money there isn’t always an easy way for shareholders to access the profits. Unfortunately, companies weren’t earning enough to keep up with the prediction, making it impossible to support their high valuations. Initially, investors felt excited about the potential growth of the companies involved, and that resulted in skyrocketing stock prices. If you take a look back at the “dot-com boom,” earnings came in substantially less than investors predicted. But since many factors play a role in this evaluation, investors can never guarantee this prediction will materialize. Conversely, if earnings are dropping, this is a sign the stock price might decrease.Įven if a company isn’t blowing its earnings out of the water, any increase can be a sign of future profitability. Generally, if a company has strong earnings for a quarter, it’s a sign that the stock price may increase. Why Is Earnings Per Share Important?Īnalysts and investors pay close attention to a company’s earnings because it can ultimately drive the stock price. By altering that number in the equation above, the dilutive EPS then becomes $0.12, which is less than the basic EPS. If we add that to the 12 million original shares outstanding, we have a total of 14 million. Because converting options into outstanding shares raises the total number of outstanding shares without raising its net income, the EPS is dilutive.įor instance, let’s say Company A also has stock options that can be converted into two million shares outstanding. This is because companies often have dilutive securities outstanding, such as stock options, that tend to increase the number of shares outstanding. Some investors and analysts use a diluted EPS because it understates the actual amount of EPS entitled to shareholders. Here’s how the above example looks in practice: The company then announced preferred dividends of $275,000, with the total number of shares outstanding being 12 million. Because common shares are equal in nature, Company A’s EPS is $0.14. The other way is to subtract preferred dividends from net income and divide by the weighted average of shares outstanding.įor example, Company A has a net income of $2 million in the second quarter of 2020. The first is to subtract preferred dividends from net income and divide them by the end-of-period shares outstanding. There are a couple of ways to calculate a company’s EPS. This adjustment of a company’s income statement reflects the cycles of the economy and one-off expenses that may not reliably reveal a company’s profitability. Using a company’s EPS, when combined with share price, helps investors decide if the stock is fairly priced or not.Īn analyst may also use what’s called “normalized EPS.” This measurement intends to develop a more accurate portrayal of a company’s financial health. They may also evaluate the company’s share price and market cap. The number becomes more valuable when investors evaluate a company’s EPS by comparing it with other companies in the same industry. Many investors will use this number to gauge whether investing in a particular company is a savvy endeavor. If a company has high earnings per share, investors perceive them to be more profitable. While earnings are a company’s revenue minus operation expenses, earnings per share are the earnings remaining for shareholders divided by the number of outstanding shares. Earnings per share (EPS) indicates the financial health of a company.
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