Earnings per share (EPS) are earnings from initial investment reported by companies on a quarterly basis. The most common method for calculating earnings per share is dividing profit by the weighted average of the common stock.
Earnings
per share computations can fall under many categories: continuing
operations, discontinuing operations, extraordinary item, and net income. For each
category, there is a specific formula for calculating earnings per share.
Calculating EPS for net income and continuing operations, for example, requires
the following formula: preferred dividends within net income divided by
weighted average common stock. EPS can be calculated for the past year or trailing year, the
present year or current
year, and the future year or forward
year. It is an Financial
Accounting Standards Board (FASB) requirement that all companies report earnings
per share in each and every category.
Despite these requirements, companies
have great flexibility in how they choose to report quarterly earnings per
share. There are numerous variations to the common formula used and various
regulations that enable companies to choose the EPS they report. Most companies
choose to report EPS according to generally accepted accounting
principles
(GAAP). This type of EPS, referred to both as GAAP EPS and reported EPS, is not
the best indicator for investment potential, since companies can include
one-time events such as the sale of a large division to inflate earnings.
Another type of EPS, known as pro-forma or ongoing EPS, excludes such one-time
earnings in order to estimate as closely as possible earnings from core
operations.
Headline EPS is included in company
publicity and is often computed by an analyst. Targeted towards the media, this
EPS serves as a clear indicator for investors. The cash EPS is perhaps the best
computation for determining a company’s investment potential, since it is
calculated by dividing the company's operating cash
flow
with diluted shares, which include
assets such as inventories in addition to the stocks that are available on the
market. If the cash EPS is higher that the reported EPS, the company is a good
investment due to its ability to earn real cash.
Companies choose to be cautious, because if their
earnings per share do not reach analyst’s forecasts, the short-term impact on
company stocks could be negative, causing them to decrease in value. Vice
versa, if the reported EPS is higher than expectations, the stocks of the
company increase in value. Taking advantage of the positive effect rather than
the negative effect analyst forecasts could have on company stocks, companies
quickly report any causes for decreased EPS to lower expectations. It is now
common for large corporations, such as Walmart, General
Electric, and Microsoft, to have EPS that exceeds
forecasts.
Other ways in which companies attempt to ensure their
stocks do well is to have a reserve of earnings. The EPS of a quarter in which
the company does exceptionally well may be under-reported in order to
compensate for a time when EPS may be lower than forecasts. Companies sometimes
also resort to illegal accounting practices. In all, as companies find
loopholes within regulations concerning how earnings per share should be
reported, investors have to become more savvy in determining investment
benefits and risks.