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What is the Definition of Earnings per Share, its Calculation, and Use?

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Question: What is the Definition of Earnings per Share, its Calculation, and Use?

The earnings per share discussed here is simple earnings per share. Diluted earnings per share will be discussed in another article. Simple earnings per share is appropriate for most small businesses with simple capital structures.

Answer:

In the simplest terms, earnings per share gives an investor the return on their investment in a share of stock of a publicly traded firm on a share price basis. Earnings per share is often known as "the bottom line" in investing terms.

Publicly owned companies are required to report their earnings per share as the line item below the net income available to common stockholders on their income statement. Earnings per share is very important among financial ratios as it tells investors how much they have earned on their stock in the company on a share price basis. It is used extensively in the stock market as the standard of stating earnings.

Example of the Calculation of Earnings per Share (EPS)

If we use the income statement and balance sheet that we have here on the small business finance website, we can calculate earnings per share under a real-world situation.

Take a look at the income statement referenced above. You will see that the earning available to common stockholders are $84,000. Look at the balance sheet referenced above and you will see that the common stock outstanding if $400,000. Those are the two variables you need to calculate earnings per share.

Here is the formula:

Earnings per share (EPS) = Net Income Available to Common Shareholders/Number of Common Shares Outstanding

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$84,000/$400,000 = $0.21 = EPS

Usually, investors compare earnings per share to the market price per share of the stock they own. Is the market price of this stock greater than or less the share price the investors have paid for this stock? Based on the market price, how much should the earnings per share of the stock be? This is how investors evaluate their investments.

Earnings per share is the figure used in the company's price earnings ratio which is used to determine how much investors are willing to pay per share of stock.

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