How to Define Earnings Per Share: The Essential Guide for Financial Modelling

Analysts, investors, and executives all speak the language of EPS. And frankly, if you want to be taken seriously in finance, you need to speak it too.

How do you define earnings per share, and why does it matter in financial modelling? Let's cut straight to it.

Earnings per share (EPS) is a financial metric that measures the portion of a company's profit allocated to each outstanding share of common stock.

In simple terms, if profit were sliced like a pizza, EPS tells you how big each shareholder’s slice is.

The formula is straightforward: take a company's net income, subtract any preferred dividends, and divide by the weighted average number of shares outstanding.

Let's break down everything you need to know about EPS in financial modelling.

What Exactly is Earnings Per Share?

As previously stated, think of EPS like slicing a pie. The company's total profit is the pie, and each share represents a slice. EPS tells you exactly how big your slice is.

Here's the basic formula:

Basic EPS = (Net Income − Preferred Dividends) ÷ Weighted Average Shares Outstanding

Why do we subtract preferred dividends? Great question.

Preferred shareholders get paid first, before common shareholders see any profits. Since EPS measures what's available to common shareholders, we need to remove the preferred shareholders' cut from the calculation.

The "weighted average" part accounts for shares that were issued or bought back during the year. If a company had 10 million shares for six months and then issued another 2 million, using 12 million in your calculation would be misleading.

The weighted average gives you a more accurate picture.

Why Does EPS Matter in Financial Modelling?

Here's where it gets interesting. EPS isn't just a number that sits in annual reports looking pretty. It's the building block for several crucial metrics and decisions.

The Price-to-Earnings (P/E) Ratio: This is probably the most widely used valuation metric in the world. You simply divide the stock price by EPS. A company trading at £50 per share with an EPS of £5 has a P/E ratio of 10. This tells investors how much they're paying for each pound of earnings. Without accurate EPS calculations, your P/E analysis falls apart.

Earnings Forecasts: When analysts project a company's future, they often forecast EPS growth. Will EPS grow 15% next year? 20%? These projections drive stock recommendations and investment decisions worth billions.

Performance Benchmarking: Companies love comparing their EPS against competitors. It's like a scorecard: higher EPS often (but not always) indicates better profitability per share.

Executive Compensation: Many bonus structures tie directly to EPS targets. Hit certain EPS growth targets, and executives get paid. Miss them, and well... you get the picture.

Basic EPS vs. Diluted EPS: What's the Difference?

Here's something that trips up many finance professionals: there are actually two types of EPS, and you need to understand both.

Basic EPS uses the current number of shares outstanding. Simple enough. It assumes:

• No conversion of options
• No conversion of convertible debt
• No share dilution

It answers a simple question:

“How much profit did each existing share earn?”

Formula:

• Net income available to ordinary shareholders
• Divided by weighted average shares outstanding

Diluted EPS (very important in modelling) takes it a step further. It assumes that all convertible securities—stock options, warrants, convertible bonds— that are expected to convert into ordinary shares in the future, have already been converted into common shares.

This includes:

• Stock options
• Convertible bonds
• Convertible preference shares
• Restricted stock units (RSUs)

This gives you a "forecast-case scenario" for existing shareholders.

Why does dilution matter? Imagine you own shares in a company. If the company has millions of stock options outstanding that employees could exercise, those new shares would dilute your ownership.
Diluted EPS shows you what your earnings per share would look like when everyone exercises their options.

Diluted EPS = (Net Income − Preferred Dividends) ÷ (Weighted Avg. Shares + Convertible Securities)

The gap between basic and diluted EPS tells an important story. A large gap suggests significant potential dilution, which could affect future shareholder value. Smart analysts always check both figures.

Example 1: Calculating Basic EPS for a Tech Co.

Let's make this concrete with a real-world style example. A fictional technology company has the following financial data:

The calculation:

Step 1: Subtract preferred dividends from net income: $50,000,000 − $2,000,000 = $48,000,000

Step 2: Divide by weighted average shares: $48,000,000 ÷ 12,000,000 = $4.00

Result: Tech Co. Basic EPS is $4.00 per share

This means that for every share of Tech Cos. stock you own, the company earned $4.00 in profit (after paying preferred shareholders). If you own 100 shares, your slice of Tech Cos. earnings is $400.
Here's what this calculation looks like in Excel:

Figure 1: Basic EPS calculation in Excel showing the formula and result

Example 2: Calculating Diluted EPS for GlobalBank Corp.

Now let's tackle a more complex scenario. GlobalBank Corp. has several types of convertible securities that will automatically convert at a future date and dilute shareholder earnings.

GlobalBank's financial data:

First, let's calculate Basic EPS:

($120,000,000 − $5,000,000) ÷ 25,000,000 = $4.60 per share

Now for Diluted EPS:

Step 1: Calculate total diluted shares: 25,000,000 + 2,000,000 + 3,000,000 = 30,000,000

Step 2: Apply the diluted EPS formula: ($120,000,000 − $5,000,000) ÷ 30,000,000 = $3.83 per share

The dilution impact: $4.60 − $3.83 = $0.77 per share. That's a 16.7% difference—significant enough that any serious analyst would take notice.

Here's the Excel model showing both calculations:

Figure 2: Diluted EPS calculation comparing basic vs. diluted EPS

Building EPS into Your Financial Models

Understanding the formula is one thing. Building robust EPS calculations into your financial models is another.

Here are some practical tips from the trenches.

Always link to source data. Never hardcode numbers in your EPS formulas. Link directly to your income statement for net income and your equity schedule for share counts. When those numbers update, your EPS calculation updates automatically.

Build flexibility for scenarios. Your model should handle different share count scenarios—what happens if the company issues more shares? What if they buy back shares? Build switches or dropdown menus to toggle between scenarios.

Track the trend. A single year's EPS tells you something. Five years of EPS tells you much more. Build historical EPS data into your models to identify trends. Is EPS growing? Declining? Volatile? The trend matters as much as the absolute number.

Don't forget quarterly EPS. Companies report quarterly, and so should your models. Quarterly EPS helps you track performance between annual reports and catch problems early.

Common EPS Mistakes to Avoid

Even experienced financial modellers make these errors. Don't be one of them.

• Using the wrong share count. End-of-period shares and weighted average shares are different. EPS uses weighted average—always. Using the wrong number will throw off your entire calculation.
• Forgetting preferred dividends. If a company has preferred stock, you must subtract those dividends. Skip this step, and you'll overstate EPS.
• Ignoring dilution. Focusing only on basic EPS misses half the picture. Always calculate and analyse both basic and diluted EPS.
• Comparing apples to oranges. Be careful when comparing EPS across companies. Different accounting methods, capital structures, and industries make direct comparisons tricky. A tech startup and a mature utility company might both have $2.00 EPS, but the implications are vastly different.

The Limitations of EPS (Yes, There Are Some)

EPS is powerful, but it's not perfect. Every good analyst knows their limitations.

EPS can be manipulated. Companies can boost EPS through share buybacks without actually improving profitability. They can also use accounting tricks to inflate net income temporarily.

EPS ignores cash flow. A company can report strong EPS while burning through cash. Profitable on paper doesn't always mean profitable in reality.

EPS doesn't tell the whole story. It says nothing about debt levels, competitive position, or future growth prospects. Use EPS as one tool in your analytical toolkit, not the only one.

Putting It All Together

Earnings per share might seem like a simple concept, and at its core, it is. Profit divided by shares. But as we've seen, the devil's in the details.

Knowing when to use basic versus diluted EPS, understanding how to build EPS into dynamic financial models, and recognising its limitations separates the good analysts from the great ones.

Whether you're valuing a company for M&A, analysing investment opportunities, or building executive compensation plans, EPS is there.

It's woven into the fabric of modern finance.

The examples we walked through— the Tech company's basic EPS of $4.00 and GlobalBank's diluted EPS of $3.83—demonstrate exactly how these calculations work in practice. Keep these models handy as templates for your own work.

Understanding EPS is just the beginning. Financial modelling encompasses a vast range of skills—from building three-statement models to conducting sensitivity analyses, from valuation techniques to scenario planning.

If you're ready to take your financial modelling skills to the next level, Redcliffe Training offers comprehensive financial modelling courses designed for busy finance professionals. Our expert-led programmes cover everything from Excel fundamentals to advanced modelling techniques used by top investment banks and consulting firms.

When you're ready, join thousands of finance professionals who have accelerated their careers with Redcliffe Training.

FAQ

What is the difference between EPS and dividends?

Earnings per share (EPS) measure a company’s profitability by showing how much profit is earned for each share outstanding. Dividends are the portion of those profits that a company chooses to distribute to shareholders in cash or shares. EPS reflects earnings performance, while dividends reflect a payout decision. A company can have high EPS but pay low or no dividends if it reinvests profits, or lower EPS but still pay dividends using retained earnings.