You might know the basic meaning of what is Earning Per Share (EPS) as its name clearly indicates that it refers to a company’s profitability on a per-share basis. While this is correct, there is more to understand about EPS. Here, you will learn about its definition, formula, real-world examples, benefits, limitations, types, and what constitutes a good EPS ratio. Let’s dive deeper into the topic.
What is Earning per Share (EPS)?
Earnings Per Share (EPS) is a financial ratio that shows how much of a company’s total earnings comes under the head of each stock of the company. It offers a quick snapshot of a company’s profitability on a per-share basis to investors, allowing them to easily compare profitability across different companies without needing to analyze detailed financial statements.
A higher Earning Per Share (EPS) generally indicates better company performance and profitability, as it reflects that the company is generating more earnings on each share.
Earning per Share (EPS) - Formula
The formula for Earning Per Share (EPS) is:
EPS= Net income – Dividend on preferred stock / Weighted average shares outstanding
Where,
Net income: Net income is the total amount of profit a company makes after subtracting all expenses, including taxes and interest.
Dividend on preferred stock: If a company has issued preferred stock, it may pay dividends to preferred shareholders. These dividends are subtracted from net income when calculating EPS because EPS is calculated only for common shareholders, not for preferred ones.
Weighted average shares outstanding: Weighted average shares outstanding refers to the average number of shares a company has during a specific period. This method provides a more accurate reflection of the shares available throughout the period.
Eg: If a company had 2000 shares outstanding for half the year and 3000 shares for the other half, the calculation would be: (2000*0.5) + (3000*0.5) = 1000 + 1500 = 2500 weighted average shares.
Real World - Example of EPS
Let’s calculate the EPS of HDFC Bank
EPS= Net income – Dividend on preferred stock / Weighted average shares outstanding
Net profits: June ‘24 quarter = 16,175 Cr., March ‘24 quarter = 16,512 Cr., December ‘23 quarter = 16,373 Cr., September ‘23 quarter = 15,976 Cr.
Net income = 6,50,36,00,00,000
Dividend on preferred stock = NA
Weighted average shares outstanding = 7,60,00,00,000
EPS = 6,50,36,00,00,000 / 7,60,00,00,000 = 85.57
EPS (TTM) = 85.57
Types of Earning per Share (EPS)
Here are the different types of Earnings Per Share (EPS):
- Trailing Twelve Months (TTM) EPS: Trailing Twelve Months (TTM) EPS represents a company’s earnings per share over the most recent 12-month period. It is used to evaluate the company’s recent financial performance and profitability.
- Adjusted EPS: Adjusted EPS (Earnings Per Share) refers to earnings per share calculated after excluding non-recurring items, such as one-time gains, losses, or expenses. This measure provides a clearer perspective on the company’s core operational performance by excluding the effects of unusual or non-recurring items.
- GAAP EPS: GAAP (Generally Accepted Accounting Principles) EPS refers to Earning Per Share calculated according to GAAP standards. It includes all revenues, expenses, gains, and losses, based on standardized accounting principles.
- Ongoing EPS: Ongoing EPS reflects earnings from the company’s core operations, excluding non-recurring or extraordinary items. It provides a measure of profitability from regular business activities by excluding the impact of one-time events.
- Retained EPS: Retained EPS refers to earnings per share calculated based on retained earnings, which are the portion of net income that is not distributed as dividends but is kept within the company for reinvestment or future purposes.
- Cash EPS: Cash EPS is a type of EPS calculated based on cash flows, excluding non-cash items such as depreciation and amortization. It provides a view of earnings based on actual cash generation, offering insights into the company’s cash profitability.
- Book Value EPS: Book Value EPS (Book Value Earnings Per Share) measures earnings per share based on the company’s book value, which is calculated by dividing the company’s total net assets by the number of shares currently outstanding.
Basic EPS & Diluted EPS
Basic EPS: Basic EPS is the way to measure how much profit a company makes for each share, assuming no potential dilution from convertible securities or other financial instruments.
Basic EPS = Net Income−Preferred Dividends / Weighted Average Shares Outstanding
Note: Weighted Average Shares Outstanding is the average number of shares a company has during a period.
Diluted EPS: Diluted EPS calculates earnings per share while accounting for possible future shares from things like stock options, convertible securities, and warrants that could be converted into common shares.
Diluted EPS = Net income – Preferred dividends / Weighted average shares outstanding + Potential shares
Example: Suppose a company made INR 10,00,000 in profit, has INR 1,00,000 in preferred dividends, and currently has 10,00,000 outstanding shares. If there are 100,000 potential shares that could be created from stock options or convertible bonds:
Diluted EPS: 10,00,000 – 1,00,000 / 10,00,000 + 1,00,000 = 0.818
Benefits & Limitations of EPS
Benefits
- Simple and clear: EPS (Earnings Per Share) offers a simple and clear measure of a company’s profitability per share. It helps investors easily understand and compare earnings, providing a better assessment of a company’s profitability and financial health across different companies and time periods.
- Benchmarking tool: Investors use EPS to assess and compare the profitability of companies within the same industry or sector, making it an effective benchmarking tool.
- Trend analysis: Tracking EPS over time can reveal trends in a company’s earnings performance, indicating growth or decline.
- Investment decisions: EPS is a key metric used in valuation models like the Price-to-Earnings (P/E) ratio, which helps investors make informed investment decisions.
Limitations
- Potential for Manipulation: Companies might manipulate earnings through accounting practices or adjustments to present a more favorable EPS figure, potentially misleading investors.
- Doesn’t Consider Debt: EPS does not account for the amount of debt a company carries. It only reflects the earnings attributed to each share of the company, without considering the impact of debt on overall financial health.
- Does Not Reflect Capital Structure: EPS measures profitability per share but ignores how a company is financed, whether through debt or equity. EPS alone doesn’t reveal these financial dynamics, making it essential to consider additional metrics for a complete financial picture.
- No Cash Flow Insight: EPS alone does not provide information about a company’s cash flows or liquidity. While it measures profitability, it does not reveal how much cash the company is actually generating or how well it can meet its short-term obligations. Evaluating a company’s financial health requires looking beyond EPS to consider cash flow and liquidity metrics.
What is a Good Earning Per Share Ratio?
A “good” Earnings Per Share (EPS) ratio depends on various factors and can differ by industry and company. Here’s how to determine if an EPS ratio is favorable:
- Comparison with peers: Compare the company’s EPS with other companies in the same industry. If its EPS is higher than its peers, it could be a good sign.
- Look at Historical Trends: Analyze Historical Trends: Assess how the company’s EPS has varied over time. Steady or growing EPS suggests strong performance.
- Earnings quality: Earnings are more valuable when they come from the company’s regular business activities and are consistent, rather than from one-time events. EPS based on high-quality earnings is usually more trustworthy and shows the company’s real financial health.
- Impact of market conditions: Consider the current market and economic conditions. If a company has a strong EPS even during difficult times, it could indicate the company is stable.
- Debt and capital structure: A company with a lot of debt might have a high EPS because it’s using borrowed money to boost its earnings. However, a company with little or no debt that still has an EPS comparable to its industry peers is considered good.
Conclusion
What is Earning Per Share – Earnings Per Share (EPS) is a key financial metric that shows a company’s profitability on a per-share basis. It helps investors gauge how much profit is attributed to each share, facilitating comparisons across companies and time periods. However, while EPS is valuable for assessing financial performance, it has limitations. To make well-rounded investment decisions, it’s essential to use EPS in conjunction with other financial metrics and analyses, providing a fuller picture of a company’s financial health and operational efficiency.
FAQs
Q1. Can we buy a share only considering an EPS metric?
A1. No, making an investment decision based solely on EPS is not advisable. Although EPS offers useful insights into a company’s profitability per share, it doesn’t provide a full view of its financial health. To make a well-informed investment choice, you should consider EPS along with other metrics, such as cash flow, debt levels, competitive positioning, market conditions, etc.
Q2. What does EPS indicate?
A2. Earnings Per Share (EPS) indicates the portion of a company’s profit allocated to each outstanding share of the company. It indicates the company’s profitability for each share.
Q3. Can we use the common shares outstanding method instead of weighted average shares outstanding, for calculating EPS?
A3. Using the common shares outstanding method instead of the weighted average shares outstanding for calculating EPS is generally not recommended, because:
- Accuracy: The weighted average shares outstanding method provides a more accurate measure of EPS by accounting for changes in the number of shares throughout the reporting period.
- Regulatory compliance: Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) mandate the use of weighted average shares outstanding for EPS calculations. Deviating from this method could lead to inaccuracies and potential compliance issues.
- Reduces Distortion: The weighted average method smooths out any distortions in EPS that might happen if the number of shares changes a lot during the reporting period. It gives a more stable and accurate measure of earnings per share.
Q4. Can EPS be negative?
A4. Yes, EPS (Earnings Per Share) can be negative, it occurs when a company reports a net loss rather than a net profit.
Q5. Can we calculate the P/E ratio without EPS?
A5. No, you cannot calculate the Price-to-Earnings (P/E) ratio without EPS as the formula for P/E ratio includes EPS. EPS is a crucial component for calculating the P/E ratio.
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