written by: Tim Plaehn•edited by: Jason C. Chavis•updated: 6/28/2011
A company's earnings per share is net profit earned in relation to each share of the company's stock. Investors should understand how to calculate earnings per share and have an idea of the investment meaning of those earnings per share.
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Measuring Corporate Profits
Shareholders of a company are all partial owners of that company and the profits or earnings in effect belong to the shareholders. Shareholders and investors show know how to calculate earnings per share to determine what portion of a company's profits has accrued to each shareholder.
Shareholders do not actually receive the earnings per share. The corporation's Board of Directors decides how much of the earnings to pay out as dividends and the rest is reinvested into the business, to fund the growth of the company.
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Calculating Earnings per Share
The earnings per share calculation is the company's net earnings for the period divided by the average number of shares outstanding during the period. Corporate earnings are released quarterly and totaled for the fiscal year. The net earnings are the total revenues for the period minus all of the expenses incurred during the reporting period. A corporation will report the number of shares outstanding in the earnings report. The numbers required to calculate the earnings per share will be found in the income statement portion of a company's earnings report.
For example, here are the major numbers for the 2nd quarter of 2010 earnings report from IBM. The company's total revenues for the quarter were $23.724 billion. Total expenses were $20.338 billion, leaving a reported net income of $3.386 billion. The income statement also shows the total number of shares outstanding as 1.2786 billion shares. Dividing the net income by the number of shares results in a net income per share of $2.65.
Companies will also report a diluted earnings per share. This calculation adds the possible shares from convertible securities and warrants. In the case of IBM these securities add 18.1 million shares to the total and IBM reported an earnings per share assuming dilution of $2.61.
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Evaluating Earnings Per Share
The goal of almost every company and the investors who own the shares is to have the earnings per share grow over time. If the earnings grow, the share value should increase also. There are three ways a corporation can increase its earnings per share:
Grow the Revenues--Sounds Like a Good Idea.
Reduce Expenses--Good if it does not hurt revenues or customer service.
Reduce the number of Shares--This is why companies have share buy-back programs.
The estimating of future earnings for individual stocks is big business on Wall Street. The Wall Street analysts will issue estimates for the earnings per share in future quarters for the different stocks. When the actual quarterly earnings are released, the share price can be affected based on whether the company beat or missed the consensus earnings estimate. Investors can make their own evaluations of the future path of a company's earnings and use the Wall Street estimates to help decide if a company is a good investment or should be avoided.
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Investopedia: Earnings Per Share: http://www.investopedia.com/terms/e/eps.asp
IBM Second Quarter Earnings Announcement: http://www.ibm.com/investor/2q10/press.phtml