Earnings per share: why is it critical for an investor to understand this?




A stock is a unit of ownership in a company. The companies issue shares and then trade on stock exchanges such as the NYSE and Nasdaq. These stock exchanges have thousands of companies that are listed. How do you have a statistic that provides a baseline comparison, as well as information about the results that can be easily understood? This is where the concept of EPS arose. This is an acronym for earnings per share.
 
Earnings per share is the profit that a company has generated in a given period, generally annually, distributed among all the shares that are issued. Let me give you an example. Company A earned $ 1 million in 2007. Company A has issued and outstanding one million shares. Divide $ 1 million by 1 million shares to get $ 1 earnings per share. The numerator is the income available for distribution to shareholders. This equates to net income reduced by dividends paid to preferred shareholders. Some corporations issue preferred shares that require a fixed amount of dividends to be paid each year. Also, the number of shares could be a weighted average as companies issue stock options etc. Sometimes companies also issue convertible securities. The company cautions investors and lets them know what will happen to EPS when all shares are fully converted. This is called diluted earnings per share.
  
As with any statistic, the investor must understand that an absolute amount does not matter by itself. One has to compare it with the performance of one’s own company over a period of time, as well as with other companies in the same industry for a proper analysis. This statistic is very important and companies must report this in their financial statements.

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