Earnings per share is a company’s profit in dollars divided by outstanding shares.
Owning shares of a company is a way to invest directly in economic growth. Each shareholder is a part owner of a company, so each share represents a claim on its profits.
That way, an investor who owns more shares is exposed to more of those profits and one who owns less, less.
Naturally, companies do not give shareholders profits as such. Rather, each company’s board chooses to either reinvest those returns or to distribute them.
If distributed, the gains are given to shareholders as dividend payments, sent quarterly.
If three partners owned a private firm, each would expect to receive a portion of the firm’s profits after expenses. Divided equally by three, each owner gets a third of the profits.
Say one owner controlled half the shares and the other two controlled 25% each. Then, profits are distributed in that proportion. The three members might choose to reinvest some percentage of the profits, or take it all as cash income.
It’s the same for large corporations, just more complex. There are levels of stock ownership, for instance. Some investors hold common stock and some hold preferred stock.
Before calculating earnings per share, a company pays its preferred stock investors a special dividend.
The money left over is reportable earnings, whether it is distributed or not. That becomes the basis upon which outsiders would value the firm as a potential investment.
For most investors, earnings relative to the cost of a share is what matters. How much will it cost to buy a specific level of profit?
Moreover, most investors are looking for a company that is steadily increasing earnings, and most likely profits, over time.
Growth is the drive that attracts more investors and drives up share prices as a result. Investors are more likely to buy a stock that will give them more money in the future, as opposed to less or the same.
Earnings per share thus allows investors to compare two or more investment opportunities and fairly estimate their potential future growth.
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