In this video, learn how to compute EPS. This is important to understanding a company's stock price.
- For large companies, the most commonly discussed net income number is earnings per share, affectionately known as EPS. Earnings mean the same thing as net income. So earnings per share is just the amount of net income divided by the number of ownership shares in the company. For example, for the year ended June 30th, 2018, Microsoft's net income was 16.571 billion dollars. How long would it take me to count to 16.571 billion if I counted one number every second. Oh, not too long. Just a little bit over 500 years. That's a long time. That's a big number. 16.571 billion is a big number. And none of us really has a concrete understanding of how large the number is. It troubles accountants a little bit to be reporting a number that people can't even understand. So we report earnings per share. Think of a share of stock as evidence that I own a portion of a company. For Microsoft, there are 7.7 billion ownership shares of Microsoft out there. Some people own more than one share. Bill Gates has got a bunch. I think I've got a few through a mutual fund that I own. So let's do this. Take the net income of 16.571 billion dollars, divide it by the number of shares, 7.7 billion. What do you get? You get $2.15. We call that earnings per share. And what does the EPS number mean? If you own one share of stock, then of Microsoft's net income for the year ended June 30th, 2018, $2.15 of that belongs to you. Now, is $2.15 a number that you can understand? Sure is, anybody can understand that number. So that's the most common number in accounting, earnings per share, net income divided by the number of ownership shares of stock of a company. If you read about a company's financial statements in the news, the article is probably talking about the earnings per share. Well, that seems pretty simple. But wait, if you look at Microsoft's income statement down at the bottom you see two earnings per share numbers, two. You see the $2.15 number that we already computed. This is labeled basic earnings per share. Another number is reported, $2.13 and this is labeled diluted earnings per share. The difference between basic EPS and diluted EPS is created by the existence of potential shares. A good example of a potential share is a stock option. A Microsoft stock option gives the option holder the option but not the obligation to buy Microsoft shares from the company in the future. So the option holder is not currently a Microsoft share holder and is not included in the 7.7 billion shares currently outstanding but at any time when the option holder decides that the time is right, the option holder can exercise the option and become a Microsoft share holder. The diluted EPS calculation is a what-if calculation. What if those option holders were to exercise their options and become share holders? With new shares issued to the option holders Microsoft's earnings would be spread among more shares reducing the earnings per share for everyone. The diluted EPS calculation gives investors and potential investors an idea of what would happen to Microsoft's EPS if the existing option holders were to exercise their options.
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