First things first, what is EPS (Earnings Per Share)?
The finance industry loves acronyms. So before we dive into what would be considered a good EPS, let’s first define what EPS means.
In a nutshell, Earnings Per Share (EPS) is an indicator used to quantify how profitable a company is, and is found by calculating profit divided by shares outstanding.
What in the world does that mean? The above equation calculates EPS by taking net income (i.e. profit) and dividing it by the number of end-of-period shares outstanding. Hang tight, we’re about to jump into a vocabulary lesson, but we promise it will help clear things up.
In order to understand what preferred dividends are, it’s helpful to understand a few other terms first.
Shares vs. Stocks
Many people use the terms shares and stocks interchangeably. However, they’re not exactly the same. We’ll spare you all the finer points of difference right now, but will highlight the major difference to be aware of:
Owning stock indicates that you’ve invested in a company (or sometimes multiple companies) and therefore own a portion of said company. For example, let’s say I told you I owned stock in Tesla. From that statement, you’d understand that I am invested in Tesla and therefore, am part owner. But beyond that, you could only speculate further details of how much I’ve invested or how large of a part owner I might be.
Shares, on the other hand, are the smallest unit by which the ownership of any company is ascertained. Knowing the number of shares someone has invested in Tesla conveys the exact amount of ownership that person has in a company.
Common Stock vs. Preferred Stock
Now that we understand stocks versus shares, let’s go over the applicable differences between common stock and preferred stock.
The biggest difference to note between common stock and preferred stock is that preferred stock owners do not have voting rights in a company. However, with that drawback comes some preferential treatment when it comes to dividend payouts. Preferred shareholders legally have priority when it comes to a company’s equity (i.e. dividend payouts). So, whatever might happen to a company, a preferred shareholder has a greater claim to the company’s assets than a common shareholder would.
So, referring back to the EPS equation, you’ll notice that preferred dividends are subtracted from the company’s net profit. That’s because dividends payable to preferred shareholders are not available to common shareholders. Thus, they must be subtracted out in order to better determine the profitability of the company to a common shareholder.
End-of-Period Common Shares Outstanding
Now on to the last point of detail in the equation. What exactly are end-of-period common shares outstanding? First things first, the number of shares outstanding is simply the number of shares of a company available on the open market (i.e. what you could go out and buy in the stock market).
As you can imagine, calculating this would be a bit like trying to shoot a moving target. Companies aren’t static and shares can be quickly bought and sold. So defining a period to reference is important. Note that there are more detailed equations to specifically calculate common shares outstanding. But without getting into the weeds, end-of-period common shares outstanding is simply a static point with which to calculate and reference the number of shares available for purchase in the marketplace at the end of a relevant fiscal period.
Now, back to the big picture.
What is a good EPS?
If EPS is representative of a company’s profitability, or how much profit it can generate per share, then what would be a good EPS?
A higher EPS is better than a lower EPS
As a general rule of thumb, a higher EPS is better than a lower EPS. However, how big or small an EPS might be won’t tell you the whole story. It’s also important to assess how a company’s earnings per share has changed over time. A positive EPS with consistent growth will likely be more favorable than a negative EPS and/or one with lots of volatility.
Trying to determine an exact number to represent a “good” EPS is, unfortunately, too subjective to be helpful.
If that seems strange, think about it this way. If we were to give you a hundred bucks and ask how you felt about your spending power, you’d probably find it difficult to answer that question. That’s because, having a hundred bucks to go see a movie vs having a hundred bucks to go buy a car will feel very different.
Having a bit of context can be helpful while assessing a particular company’s EPS, but it’s important to be cautious when comparing multiple companies. It’s best to stick to competing companies within the same industry and those that have similar business models.
Part of the reason comparisons can be misleading is in the way earnings and expenses can be reported. This will impact the net income and can cause greater differences in EPS metrics.
However, when you have a handful of competitor EPS metrics, it can help you gauge a framework for what might constitute a good EPS.
Is EPS a good indicator of performance?
Here’s the bottom line. When it comes to EPS, it’s a helpful tool in assessing the profitability of a company. But, it is only one indicator, and one piece of the puzzle. Having a ‘good’ EPS is not a guarantee of future success. And having a ‘bad’ EPS is not a guarantee of future failure. In sum, while it’s a good point of reference, using EPS in conjunction with other data – such as price to earnings ratios and historical trends – will give you a much better understanding of where a company currently sits and where you can reasonably expect it to go.