Earnings Per Share (EPS) are earnings from initial investment reported by companies on a quarterly basis. The most common method for calculating EPS 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 EPS. 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.