Earnings Per Share (EPS)
Earnings Per Share (EPS) Meaning
Earnings per share or EPS is a common metric for calculating corporate value. EPS is a financial ratio that divides net earnings available to common shareholders by the average number of shares outstanding over time. It shows how much money a company makes for each share of its stock, which indicates its profitability. When examined alongside the share price and the number of shares outstanding, EPS makes more sense as an indicator of a company’s profitability and distribution amongst shareholders.
When analyzing stocks of companies within the same industry, investors usually consider the EPS as well as the share price. It is preferable to buy shares with a higher EPS because it indicates a better return on investment.
Formula of Earnings Per Share (EPS)
- Earnings per Share (EPS) = (Net Income – Preferred Dividends) / Number of Common Shares Outstanding
- Weighted Earnings Per Share: (Net Income after Tax – Total Dividends)/Total Number of Outstanding Shares
A company’s EPS is calculated by dividing its net income by its available shares. Profits and earnings referred to as net income are the remaining funds after expenses are paid by a company. To calculate EPS, you’ll need the company’s balance sheet and income statements to find the common shares, dividends paid on stocks, and net income.
Calculating the weighted number of shares for the reporting period is the best way to get accurate information, as the number of shares can fluctuate over time. We’ll also discuss significant gains or losses and possible share dilution, which are included in the financial statements of many companies.
Types of Earnings Per Share (EPS)
a) Reported EPS or GAAP EPS
b) Ongoing EPS or Pro Forma EPS
c) Retained EPS
d) Cash EPS
e) Book Value EPS
a) Reported EPS or GAAP EPS: Generally Accepted Accounting Principles are used in order to achieve this and are disclosed in SEC filings. In spite of this, GAAP can distort a company’s earnings. EPS could increase if the one-time payment is calculated as operating income under GAAP. The artificially boosted earnings per share will result if a company considers regular expenses to be unusual.
b) Ongoing EPS or Pro Forma EPS: Net income is based on ordinary income and excludes income generally accounted for as one-time income. It assists in identifying anticipated income from core business ventures, but does not assist in determining real earnings.
c) Retained EPS: Retained EPS indicates the company retains its profits instead of paying dividends to shareholders. Many business owners use retained earnings per share to pay off existing debt or to reserve for future needs, such as expansion. To calculate the retained EPS, add the net earnings to the current retained earnings and subtract the dividends paid. Shares outstanding are then divided by the remainder.
Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares.
d) Cash EPS: In order to understand a company’s financial standing, it is helpful to look at its cash EPS. This shows how much cash the company earned. Manipulating Cash earnings per share is challenging. In order to calculate it, follow these steps:
Cash EPS = Operating Cash Flow/Diluted Shares Outstanding.
e) Book Value EPS: In order to calculate the average amount of equity in each share, Book Value EPS is used. The value of a company’s stake can also be estimated if the company has to be liquidated. Since it focuses on the balance sheet, it offers a static view of a company’s performance.
Advantages/ Pros of Earnings Per Share (EPS)
a) EPS helps investors pick the most suitable investment option by comparing the performance of promising companies.
b) EPS can also be used to compare a company’s financial performance over time. Investors can find a reliable investment opportunity by investing in companies whose EPS increase steadily. A company’s irregular EPS, however, is usually not preferred by experienced investors.
c) A higher EPS indicates that the company is profitable, which may lead to an increase in dividend payouts in the future.EPS indicates dividend payout and is a vital determinant of the Price-to-Earnings ratio (P/E Ratio).
d) It is very easy to calculate EPS. EPS can be calculated simply by dividing the total profit by the number of outstanding shares. In the financial statement, both figures can be found.
e) In addition to assessing a company’s current financial status, EPS assists in tracking its historical performance.
Disadvantages/ Cons of Earnings Per Share (EPS)
Despite EPS being regarded as a powerful financial tool, it does have some drawbacks. Both business owners and investors should be aware of the following limitations:
a) It is common for business owners to manipulate the EPS to portray their venture as profitable most of the time. The majority of such attempts are made for the short term, which can be detrimental to a business’s reputation and profitability.
b) A high EPS does not necessarily reflect a company’s financial health, since cash flow is not taken into account.
c) Considering a company’s cash flow is a good way to determine its ability to pay its debts. Cash flow is not considered in EPS calculations, so a high EPS may not be a reliable indicator of a company’s solvency.
d) The share price is completely ignored when evaluating the company’s performance using EPS.
e) An earnings per share will be negative when a company makes a loss. Companies with negative EPS are hard to measure.
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