Earnings per Share (EPS) are the value of earnings per outstanding share of common stock of the company. It indicates the profitability of a company and is used to compute the profitability of a company before buying shares. It is considered to be a significant financial parameter as it helps to determine a company’s financial health. Higher EPS reflects greater profitability from the company and its overall ventures.
How are earnings per share calculated?
It is calculated by dividing the company’s net income with its total number of outstanding shares. Earnings per share can be calculated in two ways.
1. Earnings per share: Net Income after Tax/Total Number of Outstanding Shares
2. Weighted earnings per share: (Net Income after Tax – Total Dividends)/Total Number of Outstanding Shares
For instance, a company AB has a net income of Rs. 1 lakh and must also pay Rs. 2 lakh as dividends and has Rs. 4 lakh weighted average of the shares.
Therefore, the EPS of AB would be –
= Rs. (1 lakh – 2 lakh)/4 lakh
= Rs. 2 per share
Earnings per share can be calculated considering the different period
Trailing EPS: It is based on previous years’ calculation.
Current EPS: It is based on the currently available figures.
Forward EPS: It is the expected future projections and estimated figure.
Types of EPS:
|Reported EPS or GAAP EPS||Calculated as per Generally Accepted Accounting Principles.|
|Ongoing EPS or Pro Forma EPS||It does not include an unusual one-time income in the net income.|
|Retained EPS||Total net earnings and current retained earnings are subtracted from divided paid. Then further divided by the total number of outstanding shares.|
|Cash EPS||Total operating cash is divided by outstanding diluted shares.|
|Book Value EPS||Take the current balance sheet into account to calculate the EPS.|
1. Reported EPS or GAAP EPS: It is achieved by using the Generally Accepted Accounting Principles and is disclosed in the SEC filings. However, a company’s earnings can be distorted by GAAP. If the income generated through the one-time payment as operating income as per GAAP, it could shoot the EPS upwards. If a business considers regular expenses as an unusual expense, it will directly boost the earnings per share artificially.
2. Ongoing EPS or Pro Forma EPS: It is based on ordinary net income and excludes income that can be generally passed as an unusual one-time income. It helps discover anticipated income from core business ventures but also does not help with the company’s real earnings.
3. Retained EPS: The amount of profit that a company holds on to instead of distributing to its shareholders as dividends are the retained EPS. Business owners use the retained earnings to pay off existing debts, for expansion purposes or reserve it for future requirements. The retained EPS is calculated by adding the net earnings to the current retained earnings and then subtracting the total dividend paid from it. The remainder is then divided by the total number of outstanding shares.
4. Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares.
5. Cash EPS: It helps to learn about a company’s financial standing. Cash EPS signifies the exact amount of cash earned by the company. It is challenging to manipulate Cash earnings per share. It can be calculated as
Cash EPS = Operating Cash Flow/Diluted Shares Outstanding.
6. Book Value EPS: It can be used to calculate the average amount of company equity in each share. It can also be used to estimate the worth of a company’s stake if it has to be liquidated. It is a static representation of a company’s performance as it focuses on the balance sheet.
How do Earnings Per Share work?
It helps the investors to determine if investing in a company will generate more income. If a company has a higher EP, it indicates that the company may increase dividend pay-out over time. It can be used to compare the performance of companies to help pick the most suitable investment option. EPS can also be used to compare the financial standing of a company over the years. Companies that have a steady EPS increase can be a reliable investment option. Companies irregular EPS are usually not preferred by seasoned investors.
Limitations of EPS
EPS can be manipulated by business owners to project their venture as a profitable one. It can hamper the businesses profitability in the long run. EPS does not consider inflation, so the growth indicated by it may not be accurate. Cash flow is not considered in EPS calculation, which means a high EPS may not accurately signify the company’s financial health.
Before determining the profitability of a company as an investment option, investors should also check other factors. Aligning Earnings per Share with other financial parameters can give a more accurate value of the business venture’s overall scope, profitability, and market performance.
To know more about other equity ratios and analyses, visit the Angel Broking website.