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What is earnings per share or EPS?
Earnings per share or EPS is the value of earnings per share of the company’s common stock. Companies often use this metric as an indication of their value and profitability. EPS reflects the amount of money made by a business.
To derive EPS, divide the outstanding shares of stocks of the company by its net profit. The higher the EPS, the more attractive it looks to investors. EPS is not only an indicator of a company’s current financial standing but also its performance over the past years. Read on to learn more about what is eps in the share market, its calculation and its different types.
How to calculate EPS?
Earnings per share of a company can be calculated by dividing the company’s net income by the total number of outstanding shares. This EPS calculation can be done in two different ways:
1. EPS = Net Income after Tax / Total Outstanding Shares
2. Weighted EPS= (Net Income after Tax- Total Dividends) / Total Outstanding Shares
Why earnings per share is important?
- It helps in comparing the performance of promising companies and suggests which among them offers a profitable investment avenue.
- A company can use EPS as a metric to compare its financial position over the years. A steady EPS rise reflects the stability of a company, making it a sound investment option. On the other hand, investors shy away from companies with irregular EPS.
- A higher EPS is a sign of profitability, indicating that the company’s dividend payout may also increase.
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Types of Earnings per share
Generally, EPS can be classified into 3 prime categories:
- Trailing EPS– This EPS calculation is based entirely on the previous year’s numbers of a company.
- Current EPS- It is based primarily on the current projections and figures available.
- Forward EPS– Based on projected and estimated figures for the future.
There are 5 different types of EPS. Let’s look at them in detail.
- Reported EPS or GAAP EPS
It is derived by applying the Generally Accepted Accounting Principles. It is also disclosed in the SEC filings. However, GAAP may often reflect a distorted version of a company’s earnings.
A company’s EPS will increase if it generates income as operating income through a one-time payment according to GAAP. Treating regular expenses as unusual expenses will artificially boost earnings per share.
- Ongoing EPS or Pro Forma EPS
The base of this EPS is ordinary net income, and it excludes income that is generally considered a one-time, unusual income. Although this type of EPS reflects anticipated income from core business ventures, it is not an ideal indicator of the company’s real earnings.
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- Retained EPS
A company retains EPS when it keeps its profits instead of paying out dividends to shareholders. The company uses these earnings to pay off any debts it incurs during expansion. The business may also retain this EPS for future requirements.
Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares.
- Cash EPS
Cash EPS is an indicator of the company’s financial standing. It reflects the exact amount of cash a company has earned. Cash earnings per share can be calculated as follows:
Cash EPS = Operating Cash Flow/ Outstanding Shares Diluted
- Book Value EPS
Book Value EPS gives the average amount of company equity in each share. To estimate a company’s stake worth in the event of liquidation, one can use Book EPS. Since this EPS focuses primarily on the balance sheet, it is only a static representation of the company’s performance.
Drawbacks of earnings per share
- A business can easily manipulate EPS to project a profitable venture. In the long run, it tarnishes the business image and leads to investors losing trust.
- EPS calculation does not take into account the cash flow of a company. One cannot consider a high EPS as a true indicator of a company’s financial health as it does not indicate solvency. The cash flow of a company reflects its debt-repayment ability.
- EPS calculations also do not factor in inflation. Hence, this financial metric may not show the company’s actual growth. For instance, the overall prices of goods and services may go up with inflation.
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Investors use EPS as an important financial metric for gauging a company’s worth as an investment option, but they should also consider several other essential factors while evaluating a company as an investment option.
Earnings per share of a company should be considered along with other various financial parameters and not in isolation to get a clear picture of a company’s profitability and performance.
Earnings per share determine the amount of profit per share, dividend determines the amount of profit per share that is actually paid out to investors, in cash. So, in a normal scenario, the dividend is a portion of profits that is paid out, while the rest is retained by the company as the remaining EPS.
Basic EPS considers the earnings per share on common stocks issued by companies. Diluted EPS, on the other hand, considers all other securities which can be converted, such as preference shares, debentures, etc., while calculating the earnings per share.
A company XYZ has a net income of ₹10 lakhs and must pay ₹4 lakhs as dividends. It has 3 lakh outstanding shares.
So, EPS for company XYZ is:
= ₹(10 lakh – 4 lakh)/3 lakh
= ₹2 per share
There is no fixed number that determines what a good EPS ratio is. Whether the company offers a good EPS or not can be analysed, by comparing the EPS of its peers. The historic EPS values can also be considered to see how the company is growing.
Yes, a company’s EPS can be negative. It happens when the company’s income is negative, i.e., when the company is undergoing a loss. Investing in a company with negative EPS may still be worth it if the share price in the market is increasing, provided all other factors are favourable.