Why do we divide earnings by the number of shares outstanding?
We know that we cannot compare earnings of one company to another because that does not tell us how cheap or expensive a company is.
Just because DropoutEdu has $100M in net income and UnlearnEdu has $50M in net income, we cannot conclude that UnlearnEdu is cheaper. It could be the opposite.
We need to scale the earnings to something.
This makes our earnings calculation a relative measure. Not absolute. Allowing for comparisons to be drawn.
So, does GAAP accounting require companies to disclose earnings on a per share basis?
We could scale earnings to anything.
- Earnings per employee.
- Earnings per factory.
- Earnings per patent.
- Earnings per labor hour.
- Earnings per unit sold.
Etc.
All of these would be fair metrics.
Although we could take this to an extreme.
- Earnings per holiday.
- Earnings per rainy day.
- Earnings per Lakers win.
Etc.
In these cases, the number that we are scaling earnings to is meaningless to the company’s operations.
Unlike employees, factories, labor hours, units, etc which are related to the company’s operations and thus show operating efficiency, holidays, rainy days, Lakers wins are irrelevant to the company.
We need to scale earnings to something that helps create those earnings.
Bottom-line? We care about relative earnings because it allows us as investors to draw comparisons between the profitability of companies. And, we must scale those earnings on something that is tied to how those earnings are generated (fixed assets, labor, IP, etc).
