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How To Calculate And Use the EPS Formula Effectively

by Josh Biggs in Investment on 21st May 2019

Earnings per share, commonly abbreviated as EPS is a secret weapon to landing the best business deals on the market. It’s actually the most valuable metrics for identifying the best stocks in day trading. A lack of knowledge about this concept and its ramifications, however, can keep you from implementing wise decisions regarding your stock picks.

Having a clear understanding of EPS can provide deep insights into stocks and help you pinpoint if a trade is worth your investment. Plus, it plays a significant role in improving your overall trading.

What is it?

So, what is Earnings per Share?

EPS refers to a segment of an organization’s profits that are allocated to outstanding stock shares. Sounds confusing? Relax, let’s go ahead and break it down further.

Basically, the ratio of EPS is a measurement of a company’s net income that’s available to pay stockholders of its stock.

Calculating Cash EPS

To understand why using the earnings per share formula is important, you should know exactly how it’s calculated. First, you’ll need to determine the company’s operating cash flow by subtracting its operating expenses plus debts from the total revenue. Divide the obtained value by the overall number of shares offered by the company, including options as well as outstanding stock warrants issued by the firm. For instance, a company with USD 10 million in operating cash flow plus 1 million total stock shares would have cash earnings per share of10 or USD 10 of EPS.

It’s quite difficult manipulating the cash EPS value since it’s calculated using the company’s operating cash flow, which represents the amount of money the firm made after operating expenses, and debts plus other deductions from the net income are subtracted. This offers a concrete estimation of the company’s cash flow as well as actual earnings. Plus, it shows investors how the company is transparent about its finances.

Even more, cash EPS lets the investor know how much profit each share generates for the company. A high cash EPS informs investors that each share they purchase generates additional profit for the firm and increases the value of the shares. Remember, the cash EPS doesn’t come with the complications of a stock market analysis or investor confidence/pessimism in the stock market. It also provides deeper insights into the company’s stock performance when al market factors are kept constant. This is particularly essential when comparing similar stocks to establish if the stock price matches the real value of the firm’s shares.

How Is Earnings Per Share Important?

There are numerous reasons why businesses may want to consider earnings per share as a standard part of their stock research. These include:

  • Pricing of shares. The EPS ratio is a powerful variable for determining the price of certain stock shares. Besides, it can help you discover why the price of a given stock is rated at a certain level.
  • P/E ratio. When calculating the price-to-earnings (P/E) ration, earnings per share come in handy. And by using this ratio, you’ll better understand a stock’s market value based on your company’s earnings.
  • Valuing your company. EPS is an incredible tool that can help you establish the value of your company as it the profits into neat little per-share units. It’s absolutely clean and simple to understand.
  • Establishing a company’s trajectory. With the help of the EPS formula, it becomes easier determining a firm’s history with earnings per share and finding out if it is trending in a positive or negative way. A positive trajectory reflects potential profitability. In addition, it could be a clear indication that the firm will have adequate funds to reinvest part of its profits in the future, which could result in greater returns for you as an investor. Nonetheless, if the company is trending negatively, it could mean that the firm is experiencing trouble. Plus, it could be a sign that it’s stock price will drop in the future, which isn’t obviously desirable for those who’re buying the stock.
  • Predicting future growth. Being an investor, it’s important to check a company’s earnings per share before purchasing any stocks since it provides you with an idea of the firm’s potential to deliver dividends in the future.

Since the number of outstanding shares may change, simply focusing on your company’s overall income might not be a good indicator of the company’s potential to offer profits to interested traders.

Earnings per share offer an additional way of analyzing the company’s overall wellness. Even if the company’s earnings have significantly increased and neither the total shares have gone up nor the EPS increased, this may not prove so fruitful for the investor. Earnings per share provide a clear view of the company’s profitability, and there’s no doubt about that.

Looking at the EPS and cross-referencing the dividend history of the company provides you with an all-rounded look at what you may expect to get in the future. Of course, it won’t be 100% accurate, but you’ll certainly get a better idea of the company’s potential.

There are several types of EPS, including:

  • Basic Earnings per Share. When referring to EPS on a normal occasion, you’re actually talking about basic EPS. Typically, this calculation doesn’t factor in things like preferred shares or stock options.
  • Diluted Earnings Per Share. Most often, diluted earnings per share take into consideration factors such as preferred shares and stock options, which have the potential of diluting the company’s stock. Some people believe that diluted EPS provide a more realistic view of the company.
  • Trailing EPS. Examining a firm’s past provides a clear indication of what its future might hold. Trailing EPS refers to the company’s earnings per share from a period of time that has already passed. It’s usually more relevant to check out the most recent year. While several factors can affect a company’s EPS value over time, evaluating its trailing EPS does provide some incredible benefits.
  • Current EPS. This refers to a mix of certain data plus some conjecture. It’s a projection of the company’s earnings per share for the current year. Since the current EPS is a combination of actual data and projection, it provides investors with a good hint about the future trends of the EPS value.

Conclusion

Learning how to calculate and use the earnings per share (EPS) formula can help enhance your stock market prowess. Besides, it provides you with deep insights into the company’s overall well-being. So, consider including it in your repertoire so as to be able to make tactical decisions in your stock market investments.

 

 

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