how is eps used 
earnings per share is one of the most important metrics employed when determining a firm s profitability on an absolute basis it is also a major component of calculating the price to earnings p e ratio where the e in p e refers to eps by dividing a company s share price by its earnings per share an investor can see the value of a stock in terms of how much the market is willing to pay for each dollar of earnings eps is one of the many indicators you could use to pick stocks if you have an interest in stock trading or investing your next step is to choose a broker that works for your investment style comparing eps in absolute terms may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings instead investors will compare eps with the share price of the stock to determine the value of earnings and how investors feel about future growth basic eps vs diluted epsthe formula in the table above calculates the basic eps of each of these select companies basic eps does not factor in the dilutive effect of shares that could be issued by the company when the capital structure of a company includes items such as stock options warrants or restricted stock units rsu these investments if exercised could increase the total number of shares outstanding in the market to better illustrate the effects of additional securities on per share earnings companies also report the diluted eps which assumes that all shares that could be outstanding have been issued for example say the total number of shares that could be created and issued from company c s convertible instruments at fiscal year end was 23 million if this number is added to its total shares outstanding its diluted weighted average shares outstanding will be 541 million 23 million 564 million shares the company s diluted eps is therefore 1 67 billion 564 million 2 96 sometimes an adjustment to the numerator is required when calculating a fully diluted eps for example sometimes a lender will provide a loan that allows them to convert the debt into shares under certain conditions the shares that would be created by the convertible debt should be included in the denominator of the diluted eps calculation but if that happened then the company wouldn t have paid interest on the debt in this case the company or analyst will add the interest paid on convertible debt back into the numerator of the eps calculation so the result isn t distorted eps excluding extraordinary itemsearnings per share can be distorted both intentionally and unintentionally by several factors analysts use variations of the basic eps formula to avoid the most common ways that eps may be inflated imagine a company that owns two factories that make cell phone screens the land on which one of the factories sits has become very valuable as new developments have surrounded it over the past few years the company s management team decides to sell the factory and build another one on less valuable land this transaction creates a windfall profit for the firm though this land sale has created real profits for the company and its shareholders it is considered an extraordinary item because there is no reason to believe the company can repeat that transaction in the future shareholders might be misled if the windfall is included in the numerator of the eps equation so it is excluded a similar argument could be made if a company had an unusual loss maybe the factory burned down which would have temporarily decreased eps and should be excluded for the same reason eps from continuing operationsa company started the year with 500 stores and had an eps of 5 00 however assume that this company closed 100 stores over that period and ended the year with 400 stores an analyst will want to know what the eps was for just the 400 stores the company plans to continue with into the next period in this example that could increase the eps because the 100 closed stores were perhaps operating at a loss by evaluating eps from continuing operations an analyst is better able to compare prior performance to current performance eps and capitalan important aspect of eps that is often ignored is the capital that is required to generate the earnings net income in the calculation two companies could generate the same eps but one could do so with fewer net assets that company would be more efficient at using its capital to generate income and all other things being equal would be a better company in terms of efficiency a metric that can be used to identify more efficient companies is the return on equity roe eps and dividendsalthough eps is widely used as a way to track a company s performance shareholders do not have direct access to those profits a portion of the earnings may be distributed as a dividend but all or a portion of the eps can be retained by the company shareholders through their representatives on the board of directors would have to change the portion of eps that is distributed through dividends to access more of those profits eps and price to earnings p e making a comparison of the p e ratio within an industry group can be helpful though in unexpected ways although it seems like a stock that costs more relative to its eps when compared to peers might be overvalued the opposite tends to be the rule regardless of its historical eps investors are willing to pay more for a stock if it is expected to grow or outperform its peers in a bull market it is normal for the stocks with the highest p e ratios in a stock index to outperform the average of the other stocks in the index 