What is Earnings Per Share?
EPS equals net income divided by weighted average shares outstanding. If a company earns $2 billion in net income with 500 million shares outstanding, its EPS is $4.00. Basic EPS uses actual shares outstanding, while diluted EPS includes potential shares from stock options, convertible bonds, and warrants. Diluted EPS is typically 2-5% lower than basic EPS and is the more conservative measure analysts prefer.
EPS Growth and Valuation
EPS growth drives stock prices over the long term. The S&P 500's aggregate EPS has grown at roughly 6-7% annually over the past 50 years. A company growing EPS at 15% annually will double its earnings in about 5 years. The price-to-earnings (P/E) ratio divides stock price by EPS - a stock at $60 with EPS of $4.00 has a P/E of 15. Comparing P/E to EPS growth rate gives the PEG ratio, where values below 1.0 suggest undervaluation.
Key Considerations
Companies can artificially boost EPS through share buybacks without improving actual profitability. If a company buys back 10% of its shares, EPS rises roughly 11% even with flat earnings. Watch for one-time charges, accounting adjustments, and non-GAAP earnings that can distort EPS. Adjusted or operating EPS excludes unusual items but can be manipulated to paint a rosier picture. Always compare GAAP EPS alongside adjusted figures for a complete view.