Earnings Per Share (EPS) – Types & Importance

What is Earnings Per Share?

Earnings per Share or EPS is a financial ratio where you divide a company’s net earnings available to ordinary shareholders by the average outstanding shares over a specific time. It shows a firm’s ability to generate profits for its common shareholders. Moreover, the higher the EPS, the more profitable the firm is. 

For instance, suppose you compare the performance of two companies of the same industry with the same number of shares outstanding. The higher the EPS, the better the firm’s profitability. 

EPS is typically used along with a company’s share price to determine the company valuation. You can evaluate EPS through several forms, like excluding extraordinary items or on a diluted basis. 

How to calculate Earnings Per Share?

Earnings Per Share (EPS) = (Net Income – Preferred Dividends) / Number of shares outstanding

Let’s understand how to calculate EPS through an example. Suppose a firm has a Net Income of Rs 20 crore. It has preferred dividends of Rs 2 crore and a total number of outstanding common shares of 10 crores. 

Earnings Per Share = Rs 20 Crore – Rs 2 Crore / 10,00,00,000

Earnings Per Share = Rs 1.8. 

Suppose a firm has a Net Income of Rs 25 Lakh. It has preferred dividends of Rs 5 Lakh and a total number of outstanding common shares of 20 Lakh. 

Earnings Per Share = Rs 25 Lakh – Rs 5 Lakh / 20,00,000

Earnings Per Share = Re 1. 

What are Diluted Earnings Per Share?

Diluted Earnings Per Share is used in fundamental analysis to determine a company’s quality of EPS. It assumes the exercising of all convertible securities. For instance, convertible securities are warrants and employee stock ownership plans. 

Diluted Earnings Per Share = Net Income – Preferred Dividends / outstanding shares + diluted shares. 

Let’s understand Diluted EPS with an example. Suppose Company XYZ Ltd. had a Net Income of Rs 50 Crore over the past year. It did not pay dividends and had 15 crore common shares outstanding.

In addition to the 15 crore common shares outstanding, Company XYZ Ltd. grants employee stock options that can be converted into one crore additional common shares. Moreover, convertible preferred shares can be converted into three crore common shares. 

Diluted EPS = 50,00,00,000 / (15,00,00,000 + 1,00,00,000 + 3,00,00,000) = 2.63. 

Diluted EPS gives you an accurate picture of a company’s financial position. Companies issue additional shares to meet specific obligations. For example, companies may issue stock options to their employees, which can be converted into common stock, thereby issuing more shares. When a firm’s overall number of shares increases, each share is worth less, called dilution. 

What are the types of EPS?

Ongoing Earnings Per Share:

The Ongoing Earnings Per Share or Ongoing EPS considers current Profit After Tax excluding one-time income. Ongoing EPS focuses on a company’s earnings through its core business.  

Adjusted Earnings Per Share:

Adjusted Earnings per Share, called ‘headline’ earnings per share or EPS, shows losses and profits through operations that are not from the core business. 

Reported Earnings Per Share:

The formula is applied based on Generally Accepted Accounting Principles or GAAP in reported earnings per share. 

Trailing Earnings Per Share:

Trailing Earnings Per Share is a firm’s earnings generated over a prior accounting period, such as a financial year. It uses the earnings of the previous four quarters and considers real numbers instead of projections. 

Retained Earnings Per Share:

The firm holds profits in retained earnings per share rather than distributing them to shareholders through dividends. Many companies retain their earnings to repay loans or expand their business. 

It is determined by subtracting the total net and current retained earnings from the dividends paid and dividing this figure by the total number of outstanding shares. 

Cash Earnings Per Share: 

Cash Earnings Per Share is a financial performance measure that compares cash flow to the total number of shares outstanding. You can calculate cash earnings per share by dividing the total operating cash by the outstanding diluted shares. 

Book Value Earnings Per Share:

Book Value Earnings per Share indicates a company’s net asset value on a per-share basis. It takes the current balance sheet into account when calculating the EPS. 

What is the significance of EPS?

• EPS helps you understand if investing in a company is profitable. For instance, continuous EPS growth indicates a firm’s profitability and the ability to pay a higher dividend over time. 
• You can track a company’s current financial position and historical performance using EPS. For instance, companies with rising EPS are an excellent option, whereas you may avoid those with declining EPS. 
• EPS indicates dividend payout and is a vital determinant of the Price-to-Earnings ratio (P/E Ratio). 

Conclusion:

• EPS shows how much companies make for each share and how much of the company’s profits accrue to shareholders. 
• It would help if you judged the EPS based on the P/E Ratio, the company’s share price and the earnings yield.