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Investing for women: How does the EPS earnings per share formula work?

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Earnings per share (EPS) refers to the amount of a company’s profit that is allocated to each share of common stock. Earnings per share gives a good idea of the company in question’s profitability. Company’s often report EPS that is altered for extraordinary items and the possibility of share dilution.

Calculating EPS

The formula: Net income – preferred dividends/weighted average common shares

In order to calculate the EPS of a company, its balance sheet and income statement are examined to find a selection of factors– the weighted average number of common shares, returns paid on preferred stock (if existent), as well as the company’s profits. There is always the possibility that the number of shares can change over a period of time, and is therefore a wise to use a weighted average number of common shares over the reporting term. All stock dividends or splits that take place must be shown in the calculation of the weighted average number of shares outstanding.

Varying types of eps

Basic and Diluted EPS are two different forms of the earnings per share formula. Basic EPS is an approximate measurement of the portion of a company’s profit that can be allocated to one share of its stock. Basic EPS not take into consideration the chance that shares could be diluted by the company by means of new share issuances. The total number of outstanding shares that a company has in the market could increase if investments such as warrants, stock options, and restricted stock units are applied. In order to give a better picture of the effects of added financial instruments on per-share earnings, companies also provide a report of the diluted EPS. The diluted EPS assumes all shares that have the possibility to be outstanding have been issued.

For example, say that the number of shares that could be created and issued from a company’s convertible instruments for one year was $38 million. If this $38 million is added to the total shares outstanding (lets so $600 million for this example), the diluted weighted average shares outstanding would come to $638 million ($600 million + $38 million). This would mean that the company’s diluted EPS equates to their basic EPS (say $3 billion for this example)/638 million, which equals $4.70.

Expanding on basic eps: earnings per share can be altered both purposely and non-purposely because of a result of a number of factors. Analysts use different versions of basic EPS in an attempt to avoid the most prevalent ways that EPS can be inflated. These variations might include “Earnings Per Share Excluding Extraordinary Items,” or “Earnings Per Share from Continuing Operations.”

Earnings per share excluding extraordinary items: An extraordinary item refers to a gain or loss on a company’s income statement that has resulted from an unusual/infrequent event, i.e. one which would be difficult to replicate. Shareholders/potential investors could be misguided if such an event is part if the numerator of the EPS calculation – it is therefore excluded. The formula for EPS excluding extraordinary items is:

Net income – pref.div(+or-)extraordinary items / weighted average common shares

Earnings per share from continuing operations

An example – if a company were to start the financial year with 700 stores with an EPS of $4.00, but close 200 of these stores over the year and end with 500, it would be in the best interest of an analyst/potential investor to know what the EPS was for the company with 500 as opposed to 700, since this is what they will be moving forward with. This could be positive or negative since the EPS could decrease or increase. If an analyst wishes to compare previous performance against present performance, they are best to evaluate EPS from continuing operations. The formula from EPS Continuing Operations is:

Net income – pref.div(+or-)extraordinary items(+or-)discontinued operations / weighted average common shares

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