A secured bond has an asset as collateral backing up a person’s investment while an unsecured one doesn’t have collateral backup. Here’s more about differences.
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Market capitalization (market cap) represents the total market value of a company’s outstanding shares. A company’s market capitalization, or market cap, provides a good measure of its size and value versus revenue or sales figures.
Knowing what the market cap is for a given company can help investors compare it to other companies of a similar size.
Note the market cap (the value of a company’s total equity) is different than a company’s market value, which is a more complex calculation based on various metrics, including return-on-equity, price-to-earnings, and more.
Key Points
• Market capitalization (market cap) represents the total market value of a company’s outstanding shares and provides a measure of its size and value.
• Market cap helps investors compare companies of similar size and evaluate their potential risk and reward.
• Companies are categorized into small-cap, mid-cap, large-cap, and mega-cap based on their market cap range.
• Smaller companies (nano-cap and micro-cap) can be riskier but offer growth opportunities, while larger companies (large-cap and mega-cap) tend to be more stable.
• Market cap can be calculated by multiplying the current price per share by the number of outstanding shares.
Analysts, as well as index and exchange-traded fund (ETF) providers commonly sort stocks into small-, mid-, and large-cap stocks, though some include a broader range that goes from micro or nano-cap stocks all the way to mega cap on the large end.
The size limits of these categories can change depending on market conditions but here are some rough parameters.
Nano- and micro-cap companies are those with a total market capitalization under $300 million. Some define nano-cap stocks as those under $50 million, and micro-cap stocks as those between $50 million and $300 million.
These smaller companies can be riskier than large-cap companies (though not always). Many microcap stocks trade over-the-counter (OTC). Over-the-counter stocks are not traded on a public exchange like the New York Stock Exchange (NYSE) or Nasdaq. Instead, these stocks are traded through a broker-dealer network.
As a result there may be less information available about these companies, which can make them difficult to assess.
Small-cap companies are considered to be in the $300 million to $2 billion range. They are generally younger and faster-growing than large-cap stocks. Investors often look to small-caps for growth opportunities.
While small-cap companies have historically outperformed large-caps, these stocks can also be more risky, and may require more due diligence from would-be investors.
Mid-cap companies lie between small- and large-cap companies, with market caps of $2 billion to $10 billion.
Some investors may find mid-cap stocks attractive because they can offer some of the growth potential of small-caps with some of the maturity of large-caps. But mid-cap stocks likewise can share some of the downsides of those two categories, being somewhat vulnerable to competition in some cases, or lacking the impetus to expand in others.
Large-cap stocks are those valued between $10 billion and $200 billion, roughly. Large-cap companies tend not to offer the same kind of growth as small- and mid-cap companies. But what they may lack in performance they can deliver in terms of stability.
These are the companies that tend to be more well established, less vulnerable to sudden market shocks (and less likely to collapse). Some investors use large-cap stocks as a hedge against riskier investments.
Mega cap describes the largest publicly traded companies based on their market capitalization. Mega cap stocks typically include industry-leading companies with highly recognizable brands with valuations above $200 billion.
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To figure out a company’s market cap, simply multiply the number of outstanding shares by the current price per share. If a company has 10 million outstanding shares of stock selling for $30 per share, the company’s market cap is $300 million.
Share prices fluctuate constantly, and as a result, so does market cap. You should be able to find the number of outstanding shares listed on a company’s balance sheet, where it’s referred to as “capital stock.” Companies update this number on their quarterly filings with the Securities and Exchange Commission (SEC).
The formula for determining a company’s market cap is fairly simple:
Current price per share x Total # of outstanding shares = Market capitalization
Remember that the share price doesn’t determine the size of the company or vice versa. When measuring market cap you always have to look at the share price multiplied by the number of outstanding shares.
• Company A could be worth $100 per share, and have 50,000 shares outstanding, for a total market cap of $5 million.
• Company B could be worth $25 per share, and have 20 million shares outstanding, for a total market cap of $500 million.
In some cases, market cap can change if the number of stocks increases or decreases. For example, a company may issue new stock or even buy back stock. When a company issues new shares, the stock price may dip as investors worry about dilution.
Stock splits do not increase market share, because the price of the stock is also split proportionally.
Changes to the number of shares are relatively rare, however. More commonly, investors will notice that changes in share price have the most frequent impact on changing market cap.
💡 Quick Tip: If you’re opening an investment account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
If you’re new to investing, you may assume a company’s share price is the clearest indicator of how large a company is. You may even assume it’s as important in choosing a stock as market cap.
While the share price of a company tells you how much it costs to own a piece of the company, it doesn’t really give you any hints as to the size of the company or how much the company is worth.
Market cap, on the other hand, might give you some hints about how a particular stock might behave. For example, large companies may be more stable and experience less volatility than their smaller counterparts.
Recommended: Intrinsic Value vs. Market Value
Understanding the market cap of a company can help investors evaluate the company in the context of other companies of similar size.
For instance, as noted above market cap can clue investors into stocks’ potential risk and reward, in part because the size of a company can be related to where that company is in its business development. Investors can also evaluate how a company is doing by comparing its performance to an index that tracks other companies of a similar size, a process known as benchmarking.
• The S&P 500, a common benchmark, is a market-cap weighted index of the 500 largest publicly traded U.S. companies.
• The S&P MidCap 400, for example, is a market-cap weighted index that tracks mid-cap stocks.
• The Russell 2000 is a common benchmark index for small cap stocks.
Within this system, companies with higher market cap make up a greater proportion of the index. You may often hear the S&P 500 used as a proxy for how the stock market is doing on the whole.
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Here are some characteristics of larger market-cap companies versus smaller-cap stocks:
Volatility: Larger companies, also often dubbed blue-chip stocks, tend to be less volatile than smaller stocks and tend to offer steady returns. What’s more, compared to larger companies, they have relatively few resources, such as access to cheaper credit and access to liquidity.
Revenue: Larger stocks tend to have more international exposure when it comes to their sales and revenue streams. Meanwhile, smaller stocks can be more oriented to the domestic economy.
Growth: Smaller companies tend to have better odds of offering faster growth.
Valuation: Larger stocks tend to be more expensive than smaller ones and have higher valuations when it comes to metrics like price-to-earnings ratios.
Dividends: Many investors are also drawn to large cap stocks because companies of this size frequently pay out dividends. When reinvested, these dividends can be a powerful driver of growth inside investor portfolios.
So how do you use market cap to help build a portfolio? Market cap can help you choose stocks that could help you diversify.
Building a diversified portfolio made up of a broad mix of investments is a strategy that can help mitigate risk.
That’s because different types of investments perform differently over time and depending on market conditions. This idea applies to stock from companies of varying sizes, as well. Depending on market conditions, small, medium, and large cap companies could each beat the market or trail behind.
Because large-cap companies tend to have more international exposure, they might be doing well when the global economy is showing signs of strength. On the flip side, because small-cap companies tend to have greater domestic exposure, they might do well when the U.S. economy is expected to be robust.
Recommended: Guide to Investing in International Stocks
Meanwhile, larger-cap companies could also be outperforming when there’s a downturn, because they may have more cash at hand and prove to be resilient. In recent years, the biggest companies in the U.S. have been linked to the technology. Therefore, picking by market cap can have an impact on what kind of sectors are in an investor’s portfolio as well.
Float is the number of outstanding shares that are available for trading by the public. Therefore, free-float market cap is calculating market cap but excluding locked-in shares, typically those held by company executives.
For example, it’s common for companies to provide employees with stock options or restricted stock units as part of their compensation package. These become available to employees according to a vesting schedule. Before vesting, employees typically don’t have access to these shares and can’t sell them on the open market.
The free-float method of calculating market cap excludes shares that are not available on the open market, such as those that were awarded as part of compensation packages. As a result, the free-float calculation can be much smaller than the full market cap calculation.
However, this method could be considered to be a better way to understand market cap because it provides a more accurate representation of the movement of stocks that are currently in play. Many of the major indexes, such as the S&P 500 and the MSCI indices, use the free-float method.
While market cap is the total value of shares outstanding, enterprise value includes any debt that the company has. Enterprise value also looks at the whole value of a company, rather than just the equity value.
Here is the formula for enterprise value (EV):
Market cap + market value of debt – cash and equivalents.
A more extended version of EV is here:
Common shares + preferred shares + market value of debt + minority interest – cash and equivalents.
Market capitalization is a common way that analysts and investors describe the value and size of different companies. Market cap is simply the price per share multiplied by the number of outstanding shares. Given that prices fluctuate constantly, so does the market cap of each company, but the parameters are broad enough that investors generally know whether a company is a small cap vs. a mid cap vs. a large or mega cap.
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In theory there is no cap on market cap; i.e. there is no maximum size a company can be. As of Aug. 21, 2023, the top five biggest companies by market cap, according to Forbes, are: Apple ($2.744 trillion), Microsoft ($2.353 trillion), Saudi Aramco ($2.224 trillion), Alphabet (Google) ($1.624 trillion), Amazon ($1.336 trillion).
A company’s market cap can grow if the share price goes up.
The market cap of any company is neither good nor bad; it’s simply a way to measure the company’s size and value relative to other companies in the same sector or industry. You can have mega cap companies that underperform and micro-cap companies that outperform.
SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
SOIN0823036
Broadly speaking, Class A, Class B, and Class C shares are different categories of company that have different voting rights and different levels of access to distributions and dividends. Companies may use these tiers so that certain key shareholders, such as founders or executives, have more voting power than ordinary shareholders. These shareholders also may have priority on the company’s profits and assets, and may have different access to dividends.
Not all companies have alternate stock classes. And what can make share categories even more complicated is that while the classifications are common, each company can define their stock classes, meaning that they can vary from company to company. That makes it even more important for investors to know exactly what they’re getting when they purchase a certain type of stock. Understanding how different share classes typically differ can help when making investment decisions or analyzing business news.
Key Points
• Class A, Class B, and Class C shares are different categories of company stock with varying voting rights and access to dividends.
• Companies may use different share classes to give certain shareholders more voting power and priority on profits.
• Share classes can vary from company to company, making it important for investors to understand the specific terms and differences.
• Class A shares generally have more voting power and higher priority for dividends, while Class B shares are common shares with no preferential treatment.
• Class C shares can refer to shares given to employees or alternate share classes available to public investors, with varying restrictions and voting rights.
When a company goes public, they are selling portions of their company, known as stocks, to shareholders.
Shareholders own a portion of the company’s assets and profits and have a say in how the company is governed. To mitigate risk and retain majority control of the company, a company can restrict the amount of stock they sell and retain majority ownership in the company. Or they can create different shareholder classes with different rights.
By creating multiple shareholder classes when they go public, a company can ensure that executives maintain control of the company and have more influence over business decisions. For example, while ordinary shareholders, or Class B shareholders, may have one vote per share owned, individuals with executive shares, or Class A shares, may have 100 votes per share owned. Executives also may get first priority of profits, which can be important in the case of an acquisition or closure, where there is only a finite amount of profit.
Different stock classes can also reward early investors. For example, some companies may designate Class A investors as those who invested with the company prior to a certain time period, such as a merger. These investors may have more votes per share and rights to dividends than Class B investors. A company’s charter, perspective, and bylaws should outline the differences between the classes.
Class differentiation has become more critical in creating a portfolio in recent years because investors have access to different classes in a way they may not have had access in the past. For example, mutual funds frequently divide their shares into A, B, and C class shares based on the type of investor they want to attract.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
Just like there are different types of stock, there are different types of shareholders. Because different stock classes have such different terms, depending on the company, investors may use additional terminology to describe the stock they hold. This can include:
Investors who buy preferred shares may not have voting rights, but may have access to a regular dividend that may not be available to shareholders of common stock.
Sometimes called “ordinary shares,” common shares are stocks bought and measured on the market. Owners have voting rights. They may have dividends and access to profits, though they may come after other investors, such as executive shareholders and preferred shareholders have been paid.
These are typically offered by private companies or as part of a compensation package to employees. Companies may use non voting shares so employees and former employees don’t have an outsize influence in company decision-making, or so that power remains consolidated with the executive board and outside shareholders. Some companies create a separate class of stock, Class C stock, that comes without voting rights and that may be less expensive than other classes.
Typically, these shares are held by founders or company executives. Their stock may have outsize voting rights and may also have restrictions on the ability to sell the shares. Executive shares usually do not trade on the public markets.
Often offered to advisors or large investors of a company, these shares may have preferred rights and do not trade on public markets.
Recommended: Shares vs. Stocks: Differences to Know
While the specific attributes of Class A shares depend on the company, they generally come with more voting power and a higher priority for dividends and profit in the event of liquidation. Class A shares may be more expensive than Class B shares, or may not be available to the general public.
Many companies can have different stock tiers that trade at different prices. For instance, Company X may have Class A stock that regularly trades at hundreds of thousands of dollars while its Class B stock may trade for hundreds of dollars per share. Class B stockholders may also only have a small percentage of the vote that a Class A stockholder has. And while Class A stockholders might be able to convert their shares into Class B shares, a Class B shareholder may not be able to convert their shares into Class A shares.
Many of the tech companies that have gone public in recent years have also used a dual-share class system.
In some cases, shareholders are not allowed to trade their Class A shares, so they have a conversion that allows the owner to convert them into Class B, which they can sell or trade. Executives may also be able to sell their shares in a secondary offering, following the IPO.
💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.
Often companies refer to their Class B shares as “common shares” or “ordinary shares,” (But occasionally, companies flip the definition and have Class A shares designated as common shares and Class B shares as founder and executive shares). Investors can buy and sell common shares on a public stock exchange, where, typically, one share equals one vote. Class B shares carry no preferential treatment when it comes to dividing profits or dividends.
Some companies also offer Class C shares, which they may give to employees as part of their compensation package. These shares may have specific restrictions, such as an inability to trade the shares.
Class C shares also may also refer to alternate share classes available to public investors. Often priced lower than Class A shares and with restrictions on voting rights, these shares may be more accessible to larger groups of investors. But this is not always the case. For example, Alphabet has Class A and Class C shares. Both tend to trade at similar prices.
The difference between Class C and common stock shares can be subtle. It’s important to note that these stock classes vary depending on the company. So doing research and understanding exactly which type of shares you’re buying is key before you commit to purchasing a certain class of stock.
Recommended: Investing for Beginners: Basic Strategies to Know
Companies that offer more than one class of shares have “dual class shares.” This is a fairly common practice, and some companies offer dual class shares that automatically convert to a common share with voting privilege at a set period of time.
These may be startups who go public through IPO and do not want public investors to have a say in the company’s decision-making. There has been controversy about companies offering two share classes of stock to the public, with detractors concerned that multiple share classes may lead to governance issues, such as reduced accountability. But others argue that multiple share classes can be an asset for a public company, leading to improved performance.
Class A, Class B, and Class C shares have different voting rights and different levels of access to distributions and dividends. It can be difficult to determine which investment class is the best option for you if you’re deciding to invest in a public company that offers multiple share classes. Beyond market price, understanding how the stock will function in your overall portfolio as well as your personal investing philosophy can help guide you choose the best share class for you.
For example, investors who may be looking for shorter-term investments may choose a stock class without voting privileges. Other investors who want to be active in corporate governance may prefer share classes that come with voting rights. And some investors may be looking for stocks that provide guaranteed dividends, which may guide their decision toward one class of shares.
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SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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Mean reversion is a mathematical concept which holds that over time statistical measurements return to a long-run normal. In investing, mean reversion holds that while a market or an asset may go up and down in the short-term, over time, it returns to its long-term trend.
If traders expect a market to revert to the mean, they can use that expectation to inform their strategy going forward.
Key Points
• Mean reversion is a mathematical concept that states assets tend to return to their long-term trends over time.
• Traders may use mean reversion to inform their strategies and expect assets to return to their historical behaviors.
• Mean reversion applies not only to individual stocks, but also to sectors, commodities, and foreign currencies.
• Implementing a mean reversion strategy requires identifying patterns and timing the reversion correctly.
• Mean reversion strategies depend on regularities staying consistent, and there are risks if structural shifts occur in the market or economy.
When stocks revert to the mean, their returns or other characteristics match what they’ve been over a longer period of time than the recent past. This can mean that a stock that becomes highly volatile may revert back to being less volatile; a stock that becomes quite expensive (meaning its price far outpaces its earnings) can become cheap; and, quite importantly, the other way around. Mean reversion can work in both directions.
The mean reversion concept not only applies to individual shares, but also to whole sectors of the economy or of the stock market, like, say, consumer product companies or pharmaceutical companies or any other chunk of the market that shares enough with each other to be classed together. Alternative assets, such as commodities or foreign currencies can also revert to the mean.
The theory applies to more than just prices, the volatility of a given asset can mean revert, which can matter for trading and pricing more exotic financial products like options and other derivatives.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
With any generality or principle of the market comes the obvious question: Is there a strategy here? Can this be traded? Mean reversion trading is a strategy based on reversion to the mean happening, basically that stocks or some asset will return to its typical, long-run historical behavior.
Actually working out a mean reversion strategy is not as simple as thinking a certain stock is out of whack and waiting for things to get back to normal, it requires the ability to flag patterns to make an educated guess about when mean reversion will happen.
After all, if you just know that a stock is going to revert to the mean, you can still pile up large losses or miss out on big gains if you can’t time the reversion correctly — go too early and you’ll have to eat the stock being the “wrong” price before reversion to the mean happens, go too late and the gains have already evaporated as the change in price or returns has already occurred.
Mean reversion strategies depend on statistical and historical regularites staying, well, regular. There are some that are pretty well validated, although with sharp and scary exceptions, like that stocks tend to go up over time and outperform other asset classes. But mean reversion involves certain relationships between stocks and assets staying true over time.
In some cases, mean reversion never occurs. Companies or sectors can have continually growing returns over a long period of time if there’s some kind of structural shift in the economy or market in which they operate. This can mean that returns increase over time or stay quite high.
This can happen for a few reasons. A company could gain or lose a dominant position in a given market, technological changes can advantage certain firms and disadvantage others, such that returns move permanently (or at least close enough to permanently for a given investment strategy) to a higher level and lower to another. Or there could be a global pandemic that permanently changes the way that companies do business, or long-run inflation that impacts profitability.
There are some basic statistical and financial tools to help create mean reversion strategy. As always, active trading and trying to time the market is risky and sometimes the whole market moves up and down and that can swamp whatever strategy you might have for an individual stock or sector.
Part of implementing a mean reversion strategy is getting a sense of stock trends or a trend trading strategy, whether past movement in a stock up or down is indicative of continuing in that direction.
This can involve trying to discern bullish indicators for stocks, giving you a sense of when stock returns are likely to go up. Often traders combine this strategy with forms of technical analysis, including the use of candlestick patterns.
Recommended: Important Candlestick Patterns to Know
Alternatively, you will need to have a sense of when a stock is underperforming in order to profit from buying it before it reverts to the mean upwards.
There are many factors that institutional and retail investors need to consider when devising a mean reversion strategy.
In this case, you’ll need to think about what period of time you are using to determine a stock or sector’s “normal” or “average” behavior. This matters because it will determine how long you decide to hold a stock or when you plan to sell it before or after the reversion to the mean occurs.
To execute a mean reversion strategy, you have to know when a stock’s price movement is sufficient to execute the trade. It helps to determine this point in advance.
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What is the “normal” behavior, whether it’s price-to-equity ratio, volatility, or some other metric you’re looking at. To determine whether something is far beyond its mean, either high or low, you need a good sense of its normal range.
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Mean reversion and trading reversion to the mean is, of course, a quantitative endeavor. You need to compile statistics and make projections going forward in order to implement the strategy. But you also need to know what’s going on in the “real world” beyond the statistics.
If something is driving prices or volatility or some other metric higher or lower that’s likely to persist over time, mean reversion may not be a great bet. If, however, there’s something truly transient that’s the catalyst for large moves up and down that will then revert to the mean, then maybe the strategy is more likely to work.
As with most investments, it’s helpful to have an exit strategy determined ahead of time. This can help you limit your losses in the case that the asset ultimately does not revert to the mean.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
Mean reversion refers to an asset’s tendency to stick to typical value increases over time. Again, while volatility may play a role in short-term price or value changes, most assets will follow a long-term appreciation line, and despite short-term rises or falls in price, they’ll likely revert to the mean.
Traders who follow mean reversion strategies assume that a specific stock or sector will return to its long-term characteristics. The strategy can be helpful when determining an investing strategy for either individual assets or for a market, overall.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
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SoFi Invest® INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Claw Promotion: Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
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Earnings per share (EPS) tells investors a company’s ability to produce income for shareholders, and relates to its profitability. To calculate EPS, investors can use a ratio that takes a company’s quarterly or annual net income and divide it by the number of outstanding shares of stock on the market.
Knowing a stock’s earnings per share can be a valuable portfolio benchmarking tool. Think of EPS as GPS for where a public company is on the value map, based on how profitable it has been. Further, knowing an investment’s EPS gives investors — and portfolio managers — a good indicator of a stock’s performance over a specific period of time and its potential share price performance in the near future.
Key Points
• Earnings per share (EPS) is a ratio that measures a company’s ability to generate income for shareholders.
• EPS is calculated by dividing a company’s net income by the number of outstanding shares of stock.
• EPS is a valuable tool for benchmarking a company’s profitability and assessing its potential share price performance.
• Basic EPS includes all outstanding stock shares, while diluted EPS considers additional assets like convertible securities.
• EPS may help investors evaluate a company’s financial health, make investment decisions, and assess risk.
The starting point for any conversation about the EPS ratio is the earnings report companies issue to regulators, shareholders, and potential investors. Earnings reports play a major role, if not the starring role, during earnings season.
Publicly traded companies must, by law, report their earnings quarterly and annually. Earnings represent the net income a company generates (after taxes and after expenses are deducted), along with an estimate of what profits or losses can be expected going forward.
Typically, investment analysts, money managers and investors look at earnings as a major component of a company’s profit potential, with earnings per share a particularly useful measurement tool when gauging a company’s financial prospects.
While a company’s earnings call represents a publicly traded company’s revenues, minus operating expenses, earnings per share is different.
EPS indicates a firm’s earnings for investors, divided by the company’s number of remaining shares. Earnings per share is perhaps most optimal when comparing EPS rates of publicly traded firms operating in the same industry.
It is likely not, however, the only investment measurement tool when researching stocks and funds. Other key indicators, like share price, market share, market capitalization, dividend growth, and historical performance may also be added to the investment assessment mix. In all, though, it’s an important tool that can help determine the investing risk at play when making investing decisions.
If you’re wondering how to find earnings per share, investors can find a company’s quarterly and yearly EPS by visiting the firm’s investor relations page on its website or by plugging in the stock’s ticker symbol on major business and finance media platforms.
💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.
When companies report earnings per share, they may do so in two forms: basic EPS or diluted EPS. Each has key distinctions that investors should know about. Basic EPS is a good barometer of a firm’s financial health, while diluted EPS represents a deeper dive into a company’s financial metrics and its use of alternative assets like convertible securities.
Basic earnings per share, or basic EPS, includes all of a publicly traded company’s outstanding stock shares.
Diluted earnings per share, or diluted eps, includes all of a company’s outstanding stock shares, plus its investable assets, like stock options, stock warrants, and other forms of convertible investments tied to a company’s financial performance that could become common stocks one day.
One big takeaway for both EPS models is that any major deviation between basic and diluted EPS calculations should be considered a warning sign to investors, as it indicates that a company’s use of convertible securities is complicated and still in flux.
That scenario may indicate that the company isn’t in an ideal position to provide accurate share value to the investing public at a given time.
EPS calculations are not only a snapshot of a company’s profit performance, but they can also be used to evaluate a company’s stock price going forward. Even a moderate increase in EPS may indicate that a company’s profit potential is on the upside, and investors may take that as a sign to buy the company’s stock.
Conversely, a small decrease in a company’s EPS from quarter to quarter may trigger a red flag among investors, who could view a downward EPS trend as a larger profit issue and shy away from buying the company’s stock.
In short, the higher the EPS, the more attractive that company’s stock generally is to investors. But the higher a stock’s EPS, the more expensive its shares are likely to be.
Once investors have an accurate EPS figure, they can decide if a stock is priced fairly and make an appropriate investment decision.
There’s no hard and fast figure to point to when trying to determine a good EPS ratio. It’s perhaps better practice to look, in general, for a higher number. Context is important, too, because whether an EPS is good may depend on the expectations surrounding it.
Companies grow at different rates, and some are in different stages of growth than others. With that in mind, you might expect a different EPS for, say, a tech startup than you would for a decades-old auto manufacturer. So, there are differences and contexts to take into consideration.
But again, it may be best to look for a high number — or, to do some research to figure out what analysts and experts are looking for in terms of a specific company’s EPS. Again, this can all help you determine whether a stock is right for your portfolio and strategy in accordance with your tolerance for risk.
💡 Quick Tip: How to manage potential risk factors in a self directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Investors should prepare to dig deeper and examine what factors influence EPS figures. These factors are at the top of that list:
• EPS numbers can rise or fall significantly based on earnings’ rise or fall, or as the number of company shares rises or falls.
• A company’s earnings may rise because sales are surging faster than expenses, or if company managers succeed in curbing operations costs. Additionally, investors may get a “false read” on EPS if too many company expenses are shed from the EPS calculation.
• A company’s number of outstanding shares may fall if a company engages in significant stock share buybacks. Correspondingly, shares outstanding may jump when a firm issues new stock shares.
• A company’s profit margins are also a big influencer on EPS. A company that is losing money usually has a negative EPS number. (Then again, that may send a wrong signal to investors. The company could be on the path to profits, and that trend may not show up in an EPS calculation.)
• A price to earnings ratio is another highly useful metric to evaluate a stock’s share growth potential. Investors can find a P/E ratio through a proper calculation of EPS (“P” is the price per share; “E” refers to EPS), though it’s easy to look up a P/E ratio on any site that aggregates stock information.
EPS can be reported for each quarter or fiscal year, or it can be projected into the future with a forward EPS.
The EPS formula is fairly simple, and it can be used in a couple of different methods, too. The most common way to accurately gauge an EPS figure is through an end-of-period calculation.
The EPS formula is a company’s net income, minus its preferred dividends, divided by the number of shares outstanding. It looks like this:
EPS = (net income – preferred dividends) / outstanding shares
EPS is perhaps usually calculated using preferred dividends, but it can be calculated without them, too. Here are a couple of examples:
Investors can calculate EPS by subtracting a stock’s total preferred dividends from the company’s net income. Then divide that number by the end-of-period stock shares that are outstanding.
Basic EPS = (net income – preferred dividends) / weighted average number of common shares outstanding
For example, ABC Co. generates a net income of $2 million in a quarter. Simultaneously, the company rolls out $275,000 in preferred dividends and has 12 million outstanding shares of stock. In that calculation, knowing that shares of common stock are equal in value, the company’s earnings per share is $0.14.
(2,000,000 – 275,000) ÷ 12,000,000＝ 0.14
For smaller publicly traded companies with no preferred dividends, the EPS calculation is more straightforward.
Basic EPS = net income / weighted average number of common shares outstanding
Let’s say DEF Corp. has generated a net income of $50,000 for the year. As the company has no preferred shares outstanding and has 5,000 weighted average shares on an annual basis, its earnings per share is $10.
50,000 ÷ 5,000＝ 10
In any EPS calculation, preferred dividends must be severed from net income. That’s because earnings per share is primarily designed to calculate the net income for holders of common stock.
Additionally, in most EPS end-of-period calculations, a company is mostly likely to calculate EPS for end-of-year financial statements. That’s because companies may issue new stock or buy back existing shares of company stock.
In those instances, a weighted average of common stock shares is required for an accurate EPS assessment. (A weighted average of a company’s outstanding shares can provide more clarity because a fixed number at any given time may provide a false EPS outcome, as share prices can be volatile and change quickly on a day-to-day basis.)
The most commonly used EPS share model calculation is the “trailing 12 months” formula, which tracks a company’s earnings per share by totaling its EPS for the previous four quarters.
Earnings per share (EPS) can be calculated by investors to get a better sense of a company’s ability to produce income for shareholders. To calculate EPS, investors can use a ratio that takes a company’s quarterly or annual net income and divide it by the number of outstanding shares of stock on the market. There are different variations of the calculation, too.
Earnings trends, up or down, make earnings per share one of the most valuable metrics for assessing investments. Four or five years of positive EPS activity is considered an indicator that a company’s long-term financial prospects are robust and that its share growth should continue to rise.
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To calculate EPS by year, investors can use the formula that subtracts preferred dividends from net income, and then divide that number by the weighted average of common shares outstanding for the given year.
Each company is different, as is the context surrounding it, so there is no general rule about what makes a “good” EPS ratio for any given stock. Instead, investors should gauge analyst expectations, and consider a company’s age, among other things, to determine if its EPS is good or bad.
Earnings per share (EPS) can be calculated with preferred dividends, or without preferred dividends, depending on the specific company.
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