Earnings per Share Ratio

Earnings per share (EPS) is the portion of a company’s profit allocated to each share of common stock. Earnings per share acts as an indicator of a company’s profitability. Reporting EPS that is adjusted for extraordinary items and potential share dilution is quite common in companies. It is also a common tool to measure overall profitability of the company and is generally expressed in dollars.

Now that we know that the EPS ratio helps in measuring the overall profitability a shareholder basis it is clear that through this ratio, a larger company’s profits per share can be compared to smaller company’s profits per share. Obviously, this calculation is heavily influenced on how many shares are outstanding. Thus, a larger company will have to split its earning amongst many more shares of stock compared to a smaller company.

Formula to calculate Earnings per Share

The calculation of earnings per share or basic earnings per share can be done by subtracting preferred dividends from net income and dividing it by the weighted average common shares outstanding. The earnings per share formula looks like this.

Earnings per share = Net Income – Preferred Dividends/ Weighted Average Common Shares Outstanding

The reason behind subtracting preferred dividends are from net income in the earnings per share calculation is because due to the ability of the EPS which only measures the income available to common stockholders. Preferred dividends are kept aside for the preferred shareholders and can’t belong to the common shareholders.

Example

Vovno, atrading Co. has net income of $40,000 during the year. Being a small company, there are no preferred shares outstanding. Vovno had $4,000 weighted average shares outstanding during the year. This is how Vovno’s EPS will be calculated:

Earnings Per Share = $40,000 – $0/$,4000

Earnings Per Share = $10

Vovno’s EPS for the year is $10. This indicates that if Vovno distributed every dollar of income to its shareholders, each share would receive 10 dollars.