What is earning per share (EPS)?
Earnings per Share, or EPS, is the measure/metrics to describe the amount of their profit that each outstanding share of common stock is given.
It is an important profitability indicator used by investors to understand the health and performance of a company.
A higher EPS means more profitability and possibly more value to shareholders because the business is generating more profits for every share. Whereas, low EPS means less profitability.
What makes EPS such an essential indicator is that it can make it possible for investors to compare companies in exactly the same industry so as to find out which ones are giving better returns relative to their share count.
Normally, consistent EPS growth is indicative of strong earning power and stability of operations, thereby representing a valuable indicator to understand investment opportunities.
Formula to calculate the EPS
EPS = (Net Income − Preferred Dividends)/End-of-Period Common Shares Outstanding
Example:
In company ABC Ltd the net income in the current period is Rs. 15 lakh. It has the preferred dividend payable of Rs. 3 lakhs and a weighted average of 5 lakh common shares outstanding during this period.
(15,00,000 – 3,00,000)/ 5,00,000Rs
= 12,00,000/5,00,000Rs
=Rs. 2.4 per share
Reported or GAAP EPS accords with Generally Accepted Accounting Principles (GAAP) and is published in filings submitted to the SEC.
But standards under GAAP sometimes make earnings misleading-as in the case of one-time payments categorized as operating income that boosts EPS or recurring costs marked as unusual.
Ongoing or Pro Forma EPS adjusts for non-recurring items and focuses on core business operations. What is presented as anticipated income from regular activities may not represent the total earnings of the company.
The retained EPS is retained earnings of a company, that is, a part of the profits that a company retains in the business rather than paying it out as dividends.
It is calculated as follows: net income is added to retained earnings, and then dividends are subtracted before being divided by the total number of outstanding shares.
Cash EPS refers to the EPS that demonstrates cash flow per share, and since it reflects real cash generated, it cannot be easily manipulated. This is calculated by taking operating cash flow divided by the total diluted outstanding shares.
Using book value EPS, one can estimate the equity per share for any company: it measures the value available in a company, should it be liquidated. On the balance sheet, the performance remains static
Every type of EPS in itself helps in adding another dimension to the analysis, helping the investor to understand a different dimension of financial health and quality of earnings.
Importance of Earning Per Share
Earnings Per Share (EPS) is a valuable number for investors because it represents the straight profitability a company generates per share.
The greater the EPS, the better a company’s ability to create profits relative to outstanding shares; shares are more attractive to investors and sometimes market prices them higher.
Apart from these considerations, EPS can help assess the prospect of dividend growth as increased earnings typically promise dividend payments that help income investors.
With EPS, the investor can compare profitability between companies and hence be able to diversify the portfolio and choose profitable stocks.
If scaled up with the P/E ratio, EPS helps determine whether a stock is selling above or below its market price since it compares the price paid for the stock with the price of its earnings. It is useful when analysing stock prices in relation to the market.
Analysing the trend of EPS also helps to reveal the trend of financial health of the company.
A steadily rising EPS is a sign of growth and stability, while variable EPS performance may indicate risk and makes seasoned investors avoid that particular stock.
Thus, it delivers a basic measure by which investors can understand profitability, making wise decisions when considering an investment.