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Sunday, September 7, 2014

Understanding Earnings Per Share

Earnings per share, or EPS, tells you how well a company is generating profit for its shareholders. When earnings per share is negative, it means the company is losing money. Raise your hand if you think losing money is a good thing. Didn't think so. Still, there are times when a negative EPS isn't unexpected.

Earnings is just another word for a company's profit -- the money it has left over after paying all its expenses. Shares of stock in that company give you a claim on its earnings, and earnings per share tells you exactly how much is attributable to each outstanding share of stock. For example, if the company has $55 million in profit during a given period and there are 100 million shares outstanding, then the EPS is 55 cents. This means each share has a claim on 55 cents of earnings. That's not to say you can show up at the front desk at company headquarters and demand your 55 cents. You'll only see cash if the board of directors, which is elected by shareholders, approves a dividend for some of the money.

High Profits, High Returns
The higher the earnings per share, the better, because it means the company is generating more profit for its shareholders. Even if you don't actually receive any dividends, a high EPS is still a good thing. Profits that aren't paid out in dividends typically get reinvested in the company. Reinvestment leads to growth, which increases the value of the firm, which increases the value of the company's shares. A negative EPS, on the other hand, means that the company is operating at a loss. With few exceptions, this is a cause for concern.

Negative EPS
Companies don't always turn a profit. Sometimes they lose money, in which case their earnings are negative. When earnings are negative, then EPS will be negative, too. A negative EPS tells you exactly how much money the company lost per share of outstanding stock, which is why you'll also see it called "net loss per share." If a company with 100 million shares loses $16 million, then its EPS is negative 16 cents. No, the company isn't going to send someone to shake you down for 16 cents per share. But you'll still "pay" for the loss in another way: A net loss decreases the value of the firm, which typically lowers the value of the stock.

CEOs don't wake up in the morning hoping that this is the day they get to report negative earnings per share. Companies want to make money, not lose it, and it's safe for an investor to assume that a negative EPS is not a good thing. That said, sometimes a negative EPS is not as big a deal. Biotechs often spend years losing money as they develop commercially viable products. Startups that are just getting off the ground might need time to build up sales and profitability. If such a company continues to narrow its losses and move toward a positive EPS, that's a good sign. Meanwhile, established companies that have to incur big one-time expenses -- writing down the value of a major asset, for example, or assuming a big liability -- might see their earnings dip into the red for a quarter or even a year. If the net loss is a disappointing anomaly rather than a depressing trend -- or if the negative EPS is expected when the company issues its guidance to shareholders -- then a negative EPS isn't necessarily a reason to panic.

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