Various financial ratios help analyze a company fundamentally before investing. One of those financial ratios is Earnings Per Share (EPS). EPS compares the company’s profit and the number of outstanding shares.
Earnings per share refer to the amount of net income available for each share of a company’s stock. A higher EPS indicates that the company records higher earnings and vice versa. However, there does not exist one ideal EPS that fits for all industries.
The Earnings per share Formula is –
EPS = (Net income – Preferred dividends)/ Total number of outstanding shares
For instance, ABC Limited records a profit of ₹50,00,000 and needs to pay ₹5,00,000 dividends to the preference shareholders. The company has a total of 10,00,000 outstanding shares.
EPS = (₹50,00,000 – ₹5,00,000)/ 10,00,000 = ₹4.5
It means the company generates ₹4.5 for each of its outstanding shares.
The weighted average number of equity shares is a denominator instead of the total number of outstanding shares, as the latter may vary over a given period.
- EPS is a financial ratio that helps analyse the company’s performance.
- The investors may also compare the EPS of multiple companies in similar industries to make an investment decision.
- EPS helps the investors to arrive at the company’s price-to-earnings ratio.
- Tracking the history of EPS may help investors decide whether investing in the company would be a good decision. If the company has a track record of steadily increased EPS, it may be a good investment option and vice versa.
It uses Generally Accepted Accounting Principles (GAAP). GAAP can distort the company’s earnings. For instance, a one-time gain from the sale of equipment or a subsidiary can be categorized as operating income under GAAP, leading to increased EPS for a respective quarter.
Additionally, a company may classify an amount of operating expenses as unusual charges to artificially increase the EPS as it avoids unusual charges in the calculation.
Ongoing EPS, also called Pro-forma EPS, aims to find EPS based on ordinary earnings from the company’s core operations, excluding expenses and revenue from unusual events. However, it does not represent a clear picture of the company’s actual earnings.
The company may not opt to distribute all of its earnings to shareholders and may retain them for paying off debts, financing expansion, etc. Such earnings may be put into the net earnings for the next accounting period.
Here is the formula to calculate retained EPS.
Retained EPS = [(Net earnings + Current retained earnings) – Dividends] / Total number of outstanding shares
Cash EPS shows a clear picture of the company’s earnings as it considers the amount of cash earned. Altering cash EPS is difficult.
Here is the formula to compute cash EPS.
Cash EPS = Operating cash flow / Diluted outstanding shares.
Book Value EPS
Book value EPS, also known as carrying value per share, is important during the liquidation of the company. It takes into account the company’s assets and liabilities and presents the average amount of equity per share.
- The companies may try to change EPS by showing higher net income or reducing the total number of outstanding shares.
- Cash flows, an important factor in finding out a company’s financial health and solvency, are not taken into account when calculating EPS.
- Considering the EPS as the sole indicator of a company’s performance can be misleading.
Basic EPS vs Diluted EPS
There can be a significant difference between basic and diluted EPS as the former is calculated considering the current total number of outstanding shares. In contrast, the latter is calculated considering convertible securities such as convertible preference shares, warrants, in-the-money options, etc. Due to this reason, the diluted EPS may be less than the basic EPS.
Here is how you can calculate basic and diluted EPS.
Basic EPS = (Net income – Preferred dividends) / Total or weighted number of outstanding shares
Diluted EPS = (Net income – Preferred dividends) / (Weighted average number of shares outstanding + The conversion of any dilutive securities such as warrants, etc.)
Difference Between EPS and Adjusted EPS
The prime difference between basic EPS and adjusted EPS is that the former considers the net income recorded by a company in a given period. The adjusted EPS is the addition or reduction of non-recurring components in the net income. For instance, a one-time gain from the sale of equipment or a subsidiary included in the earnings can result in higher adjusted EPS than basic EPS for a given period.
Frequently Asked Questions
Investors would consider higher EPS better as it indicates that the company records higher earnings per share. However, an ideal EPS differs among industries.
The key components in calculating EPS are the company’s profit after tax, conversion of dilutive securities and the current total number of outstanding shares.
Diluted EPS and Non-diluted EPS are calculated using the following formulas:
Diluted EPS = (Net income- Preferred dividends) / (Weighted average number of shares outstanding + The conversion of any dilutive securities such as warrants, in-the-money options, etc.)
Non-diluted EPS = (Net income – Preferred dividends) / Total or weighted number of outstanding shares
A higher EPS indicates that the company records higher earnings per share and vice versa. Therefore, investors may consider higher EPS better.