What Does EPS Stand For in the Stock Market?
Understanding Basic EPS and Diluted EPS
While perusing a financial news website, reading a financial magazine, or watching the financial news, you are likely to hear the phrase EPS when discussing the profitability of a given company. This may trigger your curiosity and make you wonder what EPS stands for, and whether you should care.
The Definition of EPS
Simply put, EPS is an acronym that stands for Earnings Per Share. In the financial world, there are two types of EPS figures that investors are likely to encounter, especially when studying a company's income statement in an annual report or Form 10-K: basic EPS and diluted EPS. Each of these metrics tells an investor different things.
- Basic EPS: A company's basic EPS, or basic Earnings Per Share, is the company's profits divided by the number of shares outstanding. This is usually calculated on both an annual and quarterly basis. For example, if the company had earnings of $500 million and had 250 million shares of stock issued and outstanding, its basic EPS would be $2.00, because $500 million profit divided by 250 million shares = $2.00.
- Diluted EPS: A company's diluted EPS is the same concept, except for the shares outstanding figure, which is adjusted to include shares that the company holds and which could be issued to investors in the future. If a company has a significant amount of potential dilution lurking in the books, the "real" or diluted EPS figure would be lower than the basic EPS figure in profitable years. This is because the company's net income would need to be split by more shares. Many investors are far more interested in a company's diluted EPS.
Why Basic EPS and Diluted EPS Are Important to New Investors
EPS is a very important financial metric when it comes to analyzing the financial performance of a company. Many conservative investors rely on basic EPS and diluted EPS information to calculate how much they think a stock is worth. Specifically, EPS forms the basis of several important financial ratios including:
- The Price-to-Earnings Ratio or P/E Ratio: If a stock is trading at $30, and its basic EPS for the year is $3.20, then it can be said that the firm's p/e ratio is about 9.4. The p/e ratio of a stock tells you how many years it would take a company's basic EPS to pay you back your investment cost assuming no taxes were owed on distributions, there was no growth, and all earnings were paid out as cash dividends. The p/e ratio can be inverted to calculate the earnings yield.
- The PEG Ratio: The price-to-earnings growth ratio, or PEG ratio, is a modified form of the p/e ratio that starts with basic EPS and then calculates the p/e ratio with an adjustment for the projected growth in earnings per share over the coming years. To learn more about this, read Using the PEG Ratio to Uncover Hidden Stock Gems.
- The Dividend-Adjusted PEG Ratio: Going one step further, the dividend-adjusted price-to-earnings growth ratio, or dividend-adjusted PEG ratio, is a modified form of the PEG ratio that takes the basic EPS figure and then takes into account the valuation not only for the expected growth in future earnings per share but also the dividend yield. To learn more about this, read The Dividend-Adjusted PEG Ratio Can Help You Find Undervalued Blue Chip Stocks.
Learning How to Use EPS
Figuring out which multiple of EPS to pay for a company can be tricky. Some investors set hard and fast rules, which aren't necessarily the best idea since they often don't factor in inflation, taxes, and risk, such as only paying 10x earnings for a stock. Other people pay 8.5x EPS + the expected rate of growth in EPS, a formula highlighted by legendary value investor Benjamin Graham.
Basic EPS and diluted EPS are also important because dividends are ordinarily paid out of profits. This means that if a company has EPS of $2.00, it can't afford to pay dividends of $3.00 indefinitely. It's just not possible. Dividend investors look at the percentage of EPS paid out as dividends to gauge how "safe" a company's dividend payment is. For more information on this topic, read What Is Dividend Investing?.