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It may be easy to calculate the earnings per share (EPS) for a particular stock and the math is pretty simple, but one thing that should be noted is that, there are a variety of EPS that are being used nowadays. As an investor, each type of EPS must be understood on what they represent so that the decisions they make will make profit instead of making them lose money. An example of this would be that of an EPS that was announced by a certain company may differ greatly from what was actually reported in the financial statements and the headlines.

This would then result in the stock being undervalued or overvalued depending on which type of EPS was used. Here we will look into the varieties of EPS that are out there and also discuss the pros and cons of it. EPS basically means the net income that is divided by the number of shares outstanding; this also depends on how you define shares outstanding and earnings because it will change both the denominator and numerator. Since there are so many ways of how to define earnings let’s start with the shares outstanding first.

You can classify shares outstanding in two types which is the fully diluted EPS and the primary EPS. Diluted EPS involves a complex calculation which would determine the amount of shares that would be outstanding if all of them were exercisable options, warrants, etc. Diluted EPS is the preferred choice due to the fact that it is a more conservative number that assumes that all possible shares were issued and outstanding when calculating the EPS. As the share price fluctuate, for example as the options fall into or out of money the number of diluted shares can change. But usually the number is fixed as stated in the 10-K or 10-Q. On the other hand is the primary EPS which is calculated by using the number of shares that was issued and held by the investors. Companies’ issues report using both the diluted and primary EPS and the majority will usually use the diluted EPS for calculating. But that is not always the case, as sometimes, primary and diluted EPS are the same as the company do not have any convertible, in the money options or warrants that are outstanding. Investors need to make sure what the companies are using because they can use either for their calculations.

As it has been shown in recent headline, depending on the accounting policies and assumptions of the particular companies, the EPS can whatever they want it to be. This can be done when the corporate spin doctors focus media attention on the numbers they want the masses to see in the news and this may or may not be the actual EPS that was reported in the documents and then filed. A particular company may report a high EPS based on a certain set of assumptions which in the end will make the stock look undervalued and reduces the P/E multiple. This is different from the EPS that are reported in the 10Q, which can result in an overvalued stock in the P/E basis and not to mention a much lower EPS. This is a very important detail that investors should not miss out on; they should know the type of earnings being used as this will affect the decision in their investment. There are a few types of EPS being used and we will look at each one.

The number gained from the generally accepted accounting principles (GAAP) defines the reported EPS as reported when it is filed. Using the accounting guidelines companies the companies will base their earnings on these principles. Investors should take note of is that it is possible to manipulate the EPS under GAAP, and that the earnings can be distorted even though there was no intention of manipulating the results in the first place. This can be done, for example, when a one time gain from a sale of a subsidiary or from machinery under the GAAP could be considered as operating income and this would cause the spiking of the EPS. Another way of causing the distortion in the company’s earnings is when the company classifies a large amount of normal operating expenses as an unusual charge. The unusual charge will be excluded from the calculations which in result will boost the EPS. So what investors should do is to make sure they read the footnotes properly to understand carefully what factors are included in normal earnings and so that adjustments could be made to their own calculations.

The ongoing EPS is calculations that is based upon the ongoing or normalized net income and excludes anything that would be considered an unusual one time event. The objective if the ongoing EPS is to find the stream of earnings from core operations which will then be used to forecast future EPS. Unlike the GAAP EPS which can include the sale of large one time equipment and also including unusual expense, the ongoing EPS excludes all form of such profits. Using this form of calculation to determine the EPS is called pro forma.

This will bring us to another section which is the Pro Forma EPS. It is different from the reported EPS as the pro forma EPS will usually exclude some expenses or income that were used in calculating the reported earnings. The word pro forma itself is defined as the assumptions that were used to derive whatever number that was used for discussion. An example of the pro forma EPS is when a particular company sells a large division; if they wanted to they could have excluded the revenues and expenses that were associated with that particular unit when they are reporting it in the historical results. When a company chooses to exclude some of their expenses because the management feels that those particular expenses will distort the company’s true earnings as they are non-recurring, this is also another form of pro forma EPS. One thing that is worthy to take note of is that non-recurring expenses seem to appear with increasing regularity these days. Whether the management knows what they are doing or are they building a rainy day fund to smoothen out the EPS, remains to be seen.

The EPS that is reported by the media and highlighted by the company’s press release is known as the headline EPS. The EPS number can be a few types, sometimes it could be the pro forma number or it can also be the calculations of analyst or pundits that are discussing about the company. As for sound bites, they are not reliable as they do not provide enough information to determine what EPS number is used for those sets of calculations.

The cash EPS is basically the operating cash flow of those certain companies, and it is calculated by dividing the diluted shares outstanding. Cash EPS can be considered as more reliable compared to the other forms of EPS as the numbers based on this form can be considered as pure. This is also because cash EPS cannot be manipulated as easy as the net income and it represents the real cash earned for the particular company. The calculations also include the changes in the key asset categories which will include all inventories and receivables. So take for example a company that has a reported EPS of 0.50 and a cash EPS of 1.00, these numbers are more preferable if compared to a company that has a reported EPS of 1.00 and a cash EPS of 0.50. This is because a company with cash will be in better financial condition than compared to the other companies. Despite the fact that other EPS numbers overshadowing cash EPS, this type of calculation will be expected to gain more attention as times go by.

Investors should be careful as there are many types of EPS that are being use and investors should be aware of this as well as if they are a valid representation of the company’s earnings. Because if the low P/E some stocks might look like it has great value but one needs to consider whether the assumptions that it was based upon is something that we can agree upon.