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Earnings Per Share: Understanding EPS Significance, EPS Formula with Real-life Example

EPS is an important indicator of a company's profitability and ability to generate value for a shareholder.

Earnings Per Share (EPS) Meaning and EPS Definition

Earnings per share (EPS) is a financial metric calculated by dividing the company’s net earnings available to common shareholders by the average number of outstanding shares or weighted average shares outstanding.

EPS is an important indicator of a company’s profitability and ability to generate value for a shareholder. The earnings per share formula explains how efficiently a company uses its capital to generate profit. Investors widely use EPS to evaluate a company’s financial performance.

Here, net earnings mean profit after tax (PAT), which is calculated after deducting interest, tax, and amortisation from Earnings before interest, tax, depreciation, and amortisation (EBIT).

How to calculate EPS?

The following are two formulas for determining EPS (EPS Ratio formula):

1) EPS = (PAT – Preferred Dividends) / Shares Outstanding at the end of the period,  

2) EPS = (PAT – Preferred Dividends) / Weighted Average Shares Outstanding

Earnings Per Share (EPS) are calculated by dividing profit after tax (PAT) i.e. the net income less preferred dividends add/less extraordinary items by the total number of outstanding shares. The higher the EPS, the higher would be the profitability of the company.

Different components of the EPS formula are mentioned below –

a) Preference shares

Also known as preferred stocks, are a class that typically entitles shareholders to receive fixed dividends before any dividends are paid to common, ordinary, or equity shareholders. Additionally, during liquidation, preference shareholders have priority over common shareholders in receiving their share of the company’s assets.

b) Profit After Tax (PAT)

It is a financial metric that represents the net profit a company has earned after deducting all expenses, including operational and non-operational costs, taxes, and other liabilities. PAT is a key indicator of a company’s financial performance as it signifies the profit available after all financial obligations have been met. Investors, analysts, and stakeholders widely use this metric to assess a company’s overall profitability and economic health.

c) Weighted average number of outstanding shares

When calculating the denominator, analysts often use the weighted average number of outstanding shares. Companies may issue stock throughout the year, making it difficult to determine the true outstanding shares and earnings per share. Therefore, it’s common practice to use an average number to accurately determine a company’s profits by measuring average outstanding shares.

EPS real-life example

Suppose, the profit after tax (PAT) in the financial year ended 2023-2024 for ABC Company is Rs 5,00,000. The weighted average number of outstanding shares of the company is calculated to be Rs 50,000 as of March 31, 2024. Calculate the Basic EPS of the company as of March 31, 2024.

Basic EPS formula

= (PAT – Preferred Dividends) / Weighted Average Shares Outstanding

= 5,00,000/50,000

= Rs 50 per share

Note: The company didn’t allow any preferred dividends during the financial year 2023-24. Hence, it’s not subtracted from the numerator in the formula.

Types of EPS

Basic EPS

Earnings per share are a simple way to measure how much profit a company makes for each share of its common stock or equity shareholdings. Companies with only common stock need to share this number to show how profitable they are. This measure doesn’t consider the impact of convertible securities, which could dilute the earnings per share.

Basic EPS formula

= (Net income – preferred dividends)/ weighted average of common shares outstanding during the period

Diluted EPS

Diluted earnings per share is a financial measure that shows how much net income a company generates for each share of its common stock outstanding. This calculation considers all convertible securities, such as options, warrants, and convertible preferred stock.

To calculate diluted EPS, you subtract any preferred stock dividends from the company’s net income and divide by the total number of outstanding shares, including all dilutive securities. This provides a more comprehensive measure of a company’s earnings per share than basic EPS because it considers the impact of convertible securities, like stock options or convertible bonds, on the number of outstanding shares. If these securities are converted into common shares, it can dilute the company’s earnings per share.

Diluted EPS formula

= (Net income – Preferred dividends) / (Weighted average shares outstanding during the period + Dilutive securities)

Reported EPS, or GAAP EPS

Reported EPS, or GAAP EPS, is important in financial analysis. It represents a company’s Earnings Per Share, as its official financial documents outline.

This specific EPS is calculated following the rules set by the Generally Accepted Accounting Principles (GAAP). These rules are a standardised framework that ensures companies keep their financial reporting clear and consistent.

The importance of Reported or GAAP EPS cannot be understated. For investors and financial analysts, it serves as a reliable reference point. Because it follows widely recognised accounting standards, this number offers an accurate view of a company’s profitability.

It filters out potential irregularities or creative accounting, providing a clear and straightforward picture.  When investors or stakeholders want to assess a company’s financial health without any extra details, Reported or GAAP EPS is the metric.

Ongoing EPS or Pro Forma EPS

Ongoing EPS shows a company’s earnings without one-time or non-recurring expenses. It provides a more accurate picture of a company’s regular profitability and can help predict future earnings.

On the other hand, pro forma EPS takes into account potential dilution from options, warrants, or convertible securities, as well as projected earnings from acquisitions or divestitures.

This type of EPS is often used to provide a more complete view of a company’s earnings potential. Understanding the different types of EPS and how they are calculated is important for investors to make well-informed decisions.

Retained earnings per share (EPS)

Understanding retained earnings per share (EPS) is important for investors and analysts when assessing a company’s financial health.

Retained EPS, also referred to as earnings retained in the business, is the part of a company’s net earnings that is not distributed to shareholders as dividends. It is calculated by subtracting the dividends paid to shareholders from the net earnings and then dividing the result by the total number of outstanding shares.

By examining the retained EPS, investors can understand how much of a company’s earnings are being reinvested into the business, which is vital for long-term growth.

Cash EPS

Cash EPS measures how much cash a company generates for each share. Unlike Earnings Per Share (EPS), which looks at net income, Cash EPS focuses on cash flow and shows stakeholders the actual cash generated per share.

Cash EPS is important because it is more transparent than traditional EPS. By focusing on tangible cash generated per share, it gives a clearer picture of a company’s financial health. Cash EPS is crucial for investors and analysts who want to better understand a company’s financial position.

Book Value EPS

BVPS, or Book Value EPS, is a way to figure out how much each share of a company’s stock is worth based on its assets and debts. You divide the company’s total equity by the number of outstanding shares to get this number.

This tells you the value of each share in terms of the company’s assets.

Investors use BVPS to understand a company’s financial health and growth potential. A high BVPS means the company’s assets are worth more than its debts, which is good for investors.

However, BVPS doesn’t always show the true market value of a company’s assets, so it’s important to look at other financial numbers.

Significance of EPS

Indicator of profitability

Earnings Per Share (EPS) is an essential financial metric that indicates a company’s profitability. It quantifies the amount of net income earned for each outstanding share of common stock. An increasing EPS suggests the company is generating more profits from the number of shares, making it an appealing prospect for investors.

Comparison across companies

EPS facilitates an easy comparison of companies operating in the same industry. By factoring in the number of shares outstanding, investors can effectively compare companies of varying sizes, providing valuable insights into their relative profitability.

Insight into the company’s growth potential

Investors can glean valuable insights into a company’s growth potential by analysing its EPS trend. A consistent upward trend in EPS signifies that the company is expanding and becoming more profitable, indicating its growth trajectory.

The basis for stock valuation

EPS is pivotal in stock valuation models, such as the price-to-earnings ratio (P/E ratio). This ratio compares a company’s stock price to its EPS, providing a basis for assessing whether the stock is overvalued or undervalued in the market.

Essentially, EPS offers crucial information about a company’s profitability and growth trajectory. Understanding how to calculate EPS using the EPS formula and discerning the different types of EPS is imperative for investors seeking to make informed investment decisions.

Frequently Asked Questions (FAQs)

What is the P/E (Price to Earnings) ratio and how is it related to EPS?

The denominator component in the P/E ratio is the EPS and the numerator component is the Market Price per share. It is calculated by dividing the numerator by the denominator component. The lower the P/E ratio of a company the better it is.

How do you interpret different levels of EPS?

The higher the EPS, the better is considered to be the profitability of the company.

What is Adjusted EPS?

Adjusted EPS is a company’s net profits per share after removing one-time or non-repeating costs.

Which Indian Accounting Standard/s (AS) cover EPS?

EPS determination is calculated in Indian Accounting Standard/s (AS) 20, while the calculation of EPS is covered in Indian Accounting Standard/s (AS) 33.

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Disclaimer: Investing in the Equity market in India is subject to risks, i.e. the market keeps on fluctuating. This article is purely for educational purposes. The views expressed and data provided here are by Equitypandit’s team. Kindly do not completely depend on the information provided as the risk appetite differs from individual to individual and there are various other factors in the market to determine the factors to invest in the market.

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