Net Income and EPS

Net income is the bottom line of the income statement: what a company earns after paying every cost, including interest and taxes. Earnings per share (EPS) divides net income by the number of shares, showing how much profit belongs to each share. EPS is the most quoted number in earnings season, the basis for the price to earnings ratio and the figure analysts forecast most closely. Understanding how EPS is calculated, and how it can be adjusted or influenced, helps traders read results properly.

The formulas#

net income = revenue - all expenses - interest - taxes
basic EPS = (net income - preferred dividends) / weighted average shares outstanding
diluted EPS = (net income - preferred dividends) / (weighted shares + dilutive securities)

Basic vs diluted EPS#

Diluted EPS includes shares that could be created from stock options, restricted stock units, convertible bonds and warrants. It is lower than or equal to basic EPS and is the figure most analysts use.

GAAP vs adjusted EPS#

Adjusted EPS can give a clearer view of ongoing performance, but it can also flatter results if "unusual" costs recur every year. Many analysts compare the gap between GAAP and adjusted EPS over time. See Earnings Quality and Cash Conversion.

How share count affects EPS#

• Buybacks reduce shares, raising EPS even if net income is flat. See Buybacks.
• New share issuance and stock compensation increase shares, diluting EPS. See Secondary Offerings and Rights Offerings.

Using EPS#

What can distort net income#

• One off gains, such as selling a business.
• Impairments and write downs.
• Tax changes, such as one off tax benefits.
• Changes in accounting estimates, such as longer depreciation lives.
• Mark to market gains or losses on investments.

Trailing and forward EPS#

• Trailing twelve months (TTM) EPS: sum of the last four quarters.
• Forward EPS: analysts' forecast for the next 12 months or fiscal year.

Markets price stocks largely on forward expectations, so changes in forward EPS estimates often move prices more than past results.

Quality of an EPS beat#

Not every beat is equal. A beat driven by higher revenue and better margins is usually more meaningful than one driven by a lower tax rate, a one off gain or a smaller share count. Traders read the full release to see where the extra earnings came from before deciding whether the beat is likely to repeat.

Frequently asked questions#

What is EPS?#

Earnings per share: a company's net income divided by its number of shares, showing profit attributable to each share.

What is the difference between basic and diluted EPS?#

Basic EPS uses current shares outstanding; diluted EPS also counts shares that could be created from options, convertibles and similar securities.

Why do companies report adjusted EPS?#

To exclude items they consider unusual or non cash, though investors should check whether these exclusions are reasonable.

Next, learn the cash measure many investors trust most in Free Cash Flow.