The EPS is one of the useful indicators that you may use to pick a stock. The earnings per share ratio rely on the earnings.
What is EPS - Earnings Per Share?
Earnings Per Share is an indicator of the profitability of the company and the earnings per share ratio imply that the percentage of a company's earnings is distributed to each outstanding share of a company.
Earnings per share is an indication of how much profit earned per share the company has issued and a widely used metric to tally the corporate quality. Earnings per share are used to compute the price to earnings (P/E) Valuation ratio.
The earnings per share ratio is a significant method used to compute and make an investment decision.
Earnings per share also called as Net income per share. The higher the company's EPS, the better the performance and the more profitable it is.
Earnings per share formula & How to calculate earnings per share?
The earnings per share ratio is a crucial financial metric that calculates the company’s net profit minus preferred dividends.
Then divide that figure by the average numbers of outstanding equity shares.
In a nutshell, the earnings per share formula are -
Earnings Per Share = ( Net Profit - Preferred Dividends ) / End-of-Period Common Shares Outstanding
To compute the EPS of a company, the balance sheet and income statement are used to find the End-of-Period common shares outstanding, dividends paid on preferred stock and the net income.
The weighted average number of common shares provide a more accurate outcome instead of the number of shares because the number of shares can differ over time.
Any stock dividends or splits must be reflected in the computation of the weighted average number of shares outstanding.
Earnings per share example
The calculated earnings per share for ABC company at the end of the 2021 financial year is given below -
| Net Profit | ₹ 9,00,000 |
| Preferred Dividend | ₹ 2,50,000 |
| No. of Outstanding Shares | ₹ 85,000 |
EPS = Rs (9,00,000 - 2,50,000 ) / 85,000
EPS = Rs (6,50,000 / 85,000)
EPS = Rs 7.64 per share
Therefore, the company’s EPS Or earnings per share would be Rs 7.64 per share.
Watch this video below to understand the concept of EPS in a better way.
Basic EPS vs. Diluted EPS
1. Basic EPS:
For calculating Basic EPS, we just need to know the total amount of shares outstanding of the company and its net profit after tax.
Basic EPS = (Net profit after tax and preference dividend / Weighted average number of outstanding shares of the company)
2. Diluted EPS:
It used to measure the quality of a business's EPS if all convertible securities were exercised. The Diluted EPS is always lesser than the basic EPS.
Diluted EPS = (Net Profit After Tax and Preference Dividend / Outstanding shares +Dilutive Securities)
Different types of earnings per share
There are various earnings per share and Every different earnings per share tend to exemplify a unique aspect of this financial parameter.
Earnings per share can be into three vast classifications -
1. Trailing EPS: Trailing EPS is based on last financial year ending earnings. Investors may not glimpse vastly at trailing EPS though it does not project future EPS numbers.
2. Current EPS: Current EPS is based on the current year's earnings. This computation obtains statistics from the four quarters of the current financial year.
3. Forward EPS: Forward EPS is based on the Earnings estimate for future years. Analysts or investors who want to know about the profit possibility of the company.
What are the differences between EPS and dividend?
Earnings per share are the amount of net income by the company divided by total shares, it does not say that the shareholders will actually receive that money and also used to trace a company's financial performance.
While the dividend is that portion of the profits distributed by the company to its shareholders and the rest of the portion of the EPS can be retained by the company for future growth of the company.
Out of the profits, the board of directors decide whether some or all of the profits are to be paid to the shareholders in the form of dividends.
The market price of shares is directly influenced by the earnings per share of the company.
What does Earnings Per Share tell investors?
Earnings per share is a financial ratio used in esteeming a company. Earnings per share assist the investor to infer how much profit a company earns per stock it has issued.
It also shows if a company with a very nominal increase in EPS experiences no increase in share price.
A company with a consistently increasing EPS is considered more reliable investment decisions and more growth probability.
The increasing EPS reflects the growing profitability business and good organizational efficiency of the company. A higher EPS ratio is the key ratio of a strong business.
The decreasing EPS reveals managerial inefficiency and poor financial position of the company. The decreasing EPS also reflects that a company makes huge losses.
Generally, investors should avoid such types of companies. Investors and analysts like higher EPS than lower.
EPS of a company should always be considerate about other companies and EPS is a pivotal driver to determine the market price of the share of the company.
The earnings per share ratio act as a valuable financial tool to boost the comparability between two and more companies within the same industry will make you a smart investor.
It is important to track the last few years' EPS that helps to understand the EPS growth rate and profit earned by the company.
What is a good earnings per share?
Good earnings per share do not depend on the single aspects. It may depend on the current & previous performance of a company, how it competes with its competitors and the future growth of a company.
Sometimes companies reported increasing EPS but the stock price declined if analysts were predicting higher numbers.
Also, it may be the opposite like the company announced diminishing EPS but the stock price is growing if analysts were foreseeing lesser numbers. It is important to assess the EPS, related to the company's market price.
While computing earnings per share, looking at the company's price to earnings ratio, price-earnings to growth ratio , price to sales ratio, price to book value etc. and also looking at a growing trend.
High earnings per share are the indication of better earnings, stronger fundamentals performance and then investment in the most reliable company.
Limitations of Earnings Per Share
There are some limitations to earnings per share that must be memorized by investors and analysts.
1. Most of the Company's owners tend to manipulate EPS by buying back their shares or reducing the number of outstanding shares by splitting up the shares that may impact the company's reputation and profitability in the long run.
2. Earnings per share do capture the performance of the company as it fails to consider the share price. Share prices with EPS can also be used to check the rate of return.
3. Cash flow is a crucial factor when it comes to evaluating a company's capability to pay its obligations.
Companies often focus on increasing profits. If the company does not pay its liabilities, no matter how big a company, it may be insolvent.
However, before investing in stocks or mutual funds investors should examine the different parameters and don't rely on a single parameter that provides maximum information, overall outlook and current position about the company.
