How to Use Earnings per Share

Earnings per share (EPS) is a company’s net income per share of common stock.

It’s calculated by taking the net income available to common shareholders (which is net income minus dividends for preferred shareholders and minus income attributable to noncontrolling interests) and dividing it by the weighted-average number of common shares outstanding.

Earnings per share is the most widely used measure of profit.

It’s the only ratio that public companies are required to report on the income statement: both U.S. GAAP and IFRS require this.

And earnings per share is the accounting metric you’ll hear most about in the financial news, particularly during “earnings season.”

So why do people care so much about earnings per share?

The answer has to do with valuation. Many investors value companies based on their expected future cash flows. Thus, analysts spend a lot of time trying to predict what future cash flows will be.

And what’s the best predictor of future cash flows? Surprisingly, it’s not current cash flows. It’s earnings per share. That’s right, a company’s current earnings per share is better than current cash flows when it comes to predicting future cash flows. This explains why stock performance is more correlated with earnings per share than with operating cash flow.

When you divide a company’s stock price by earnings per share, you get the P/E ratio (price-to-earnings ratio).

Companies with high P/E ratios are deemed to be expensive whereas companies with low P/E ratios are considered bargains.

But when it comes to being a measure of performance, earnings per share isn’t perfect.

• For one thing, it doesn’t account for the amount of assets or capital that was employed to achieve the earnings.
• It can be increased simply by repurchasing shares.

0:00 What is EPS and how is it calculated?
0:36 Why is EPS the most widely used measure of profit?
1:34 Why do people care so much about EPS?
2:12 P/E Ratio
3:09 PEG Ratio
3:26 Downsides to using EPS as a measure of performance
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[peter]

How do I use earnings per share to value my ape NFT?

[gorandamchevski]

You made an awesome video, and thank you for clearly explaining multiple aspects! My frustration comes from the industry and news orgs.

With buyback programs, it is increasingly easier to meet or "exceed" EPS expectations.

Investors do not get paid from EPS, they get the dividend, price appreciation or the ability to generate more cash flows by taking projects and increasing CapEx.

P/E value is more of a proxy for the terminal value - which works, but for the wrong reasons.
Try it! Use the current net income and multiply by your company's PE (say 20x), and then use the terminal value formula - your net income (if you have fcf is better) divided by the cost of equity - 10yr T Bond Rate (0.0213). Today, your cost of equity is likely not less than 6.5%

Exp: 5b (of net income or fcf) / (0.065-0.021) = 5/0.044 = 113b or 5b * 20 = 100b

To me it seems like news outlets have become increasingly sloppy at posting what matters, and they want the easy calculations. Investors have a claim on the free cash flows, not earnings (or operating cash flows)

[PezerettaDarling]

Love you videos! Can you please do a video on Time Value of Money problems? Like value of a dollar and annuity/ annuity due concepts?

[MTawfik]

I would appretiate if you clarify how Earning per share is a good indicator of cash flow than cash flow history itself, and why DCF is based on cash flow and not net income??, when to use one over the other

[morpho]

Good day sir, can you explain how businesses account for their crypto?