So before discussing Earnings per Share or EPS, the term should be defined.  EPS (Earnings per Share) is Net Income after dividends have been paid on preferred shares divided by the number of shares outstanding.  Each of those two new terms needs to be discussed.

Net Income is another term for profit.  You'll hear a range of different was of discussing income; for example, operating income is a term that's discussed often.  However, Net Income has a special meaning.  In another paper called Dollars and Sense, a company called Clayton Homes was used as an example.  Clayton Homes no longer exists as a public company; nonetheless, its income statement from 1999 will be used as an example.

The Income Statement for Clayton Homes for Fiscal Year 1999

The income statement starts with revenues earned over a given period of time, then subtracts all the expenses associated with those revenues for the same period of time.  The last figure on the income statement, the bottom line, is net income—that's where the expression "what's the bottom line" comes from. 

For completeness, the term Net Income needs to be discussed a little further.  You could take Net Income from the most recent fiscal year; alternatively, you could take Net Income for each of the most recent four quarters, add them together and use that figure for Net Income for a year of business.  Note: this method won't necessarily coincide with a fiscal or calendar year, but it gives you then figure for the most recent year of business.  Finally, if you're interested in considering what the company is doing in the future, you might want to look at Net Income projected for the next, forthcoming, four quarters and use that figure for Net Income.

So, there are lots of ways to figure Net Income, but it depends on your outlook.  The calculation is the same.  It just depends on what period of time is of interest to you.

So we have net income, to figure EPS you need to know the shares outstanding.  There's a wrinkle in this calculation too; it's similar to the discussion on Net Income.

First off, the number of shares outstanding can change from day to day.  A company can issue more shares, if shareholders and the board approves; the company can also buy back shares.  If the shares are repurchased, they're still considered issued but no longer outstanding.  So, to figure out the number of shares outstanding, some people take the number of shares on January 1 add that figure to the number outstanding the following December 31, then divide by two, which yields an insight into the average number of shares outstanding that year.  Others take the figure on the day of interest, for example, if you're trying to figure out EPS on September 2, 2008, you could divided the most recent four quarters of net income by the number of shares outstanding on the second day of September.  The last issue is to discuss is fully diluted earnings per share.  This approach is the most conservative in that it includes shares that could exist if convertible items were exercised.

The number of shares used in your calculation should match the time frame used in the calculation for Net Income.  So, for example, if you're projecting net income for the upcoming for quarters, you should also estimate the shares outstanding in that period of time.

EPS is calculated for a number of reasons.  It allows shareholders to get a handle on the earnings generated per share of the company that they own.  More importantly, EPS is used in an important calculation called the PE or Price/Earnings ratio.  That concept is discussed in another article.