Earnings Per Share (EPS): Meaning, Importance, and Formula

Earnings per share (EPS) is a key financial metric used to analyse a company’s profitability. When conducting fundamental analysis of a company, it is crucial to compare its performance with that of its competitors. In this situation, an EPS can help you understand how much earnings it makes for each of its outstanding shares.

Let us understand the EPS meaning, different types of EPS, and its calculation.

What is EPS?

The earnings per share help you understand how much profit a company earns for each of its shares. Investors use EPS for understanding a stock’s valuation and making investment decisions, as it directly shows a company’s profitability per share.

With this metric, you can evaluate how valuable your chosen company is compared to other companies within the same industry. While two companies have the same quantity of shares outstanding but have different EPS, a higher EPS indicates higher profitability.

You can evaluate how cheap or expensive a company is by simply comparing its EPS with its share price.

Formula and Calculation of EPS

The formula of earnings per share is:

EPS = (Net Income − Preferred Dividends) / Shares Outstanding at the end of the period

Let us understand the formula of EPS with an example.

EPS Calculation Example

Suppose company X has a net income with a net income of INR 10,00,000 and has to pay preferred dividends of INR 2,00,000 and has common outstanding shares of INR 4,00,000 in the current period.

The earnings per share of company X be:

INR (10,00,000 – 2,00,000)/ 4,00,000

= INR 2 per share

The income statement and balance sheet of a company are crucial for determining its EPS. However, you should always use the weighted average of the common shares to calculate a company’s EPS since the exact number of shares can differ significantly over time.

Additionally, the dividends on cumulative and non-cumulative preferred stocks affect the EPS differently. For cumulative preferred stocks, even if the company does not declare dividends in that particular year, it is subtracted from the net income.

On the other hand, in the case of non-cumulative preferred stocks, dividends are only subtracted from the net income if they have been declared. Therefore, EPS may differ depending on the dividend type used in its calculation.

You can also identify the EPS of stocks to measure company profits with PL Capital Group – Prabhudas Lilladher. While buying stocks from PL’s trading platform, you can easily find out the EPS of your chosen stock under the ‘Financials’ section.

Types of Earnings Per Share

Now that you understand the earnings per share meaning and its calculation, have a look at its different types:

• Basic EPS

A basic EPS increases the comparability of earnings among different companies. You can calculate EPS by dividing the net income available to shareholders by the weighted average number of outstanding shares. Basic EPS is always higher than the diluted EPS.

• Diluted EPS

A diluted EPS helps shareholders to evaluate the company’s profitability. The company’s earnings are credited to each common shareholder in a scenario in which all dilutive securities are transformed into common shares. Moreover, a diluted EPS is always lower than basic EPS.

• Reported EPS

Reported EPS, or generally accepted accounting principles (GAAP), is the EPS calculated after the principles and guidelines established by the GAAP. GAAP are accounting rules that companies use to prepare their financial statements.

A reported EPS shows a transparent and consistent metric of a company’s financial performance. You can calculate it by dividing the difference between net income and preferred dividends by the weighted average common shares outstanding.

• Ongoing EPS

An ongoing or pro forma EPS is an adjusted measure of earnings that does not count the non-recurring items from a company’s financial statements. This category of EPS gives an accurate picture of a company’s recurring earnings by adjusting for non-operational events like restructuring charges.

It allows you to evaluate a company’s profitability. The formula of an ongoing EPS is:

(Net income – Preferred dividends – One-time gains) / Weighted average common shares outstanding

• Adjusted EPS

Adjusted earnings per share are determined based on a company’s total earnings after removing the impact of non-recurring items. A company’s adjusted EPS focuses on the profit of core operations by providing an accurate picture to analyse future returns.

However, companies are not liable to show adjusted EPS, despite its value in evaluating a company’s financial performance.

• Cash EPS

A cash EPS provides insights into a company’s financial health by showing the total amount of cash earned. A cash EPS is difficult to manipulate and is calculated by dividing the operating cash flow by diluted shares outstanding.

• Retained EPS

A retained EPS shows how much a company retains its earnings instead of distributing them to shareholders as dividends. A lot of business owners use retained earnings per share to settle existing debts, reserve funds, or fund expansion for future needs. To calculate the retained EPS of a company, you need to add net earnings to its current retained earnings, subtract total dividends paid, and divide the remainder by the total outstanding shares.

• Book Value EPS

A book value EPS is a financial metric that determines the earnings per share based on a company’s book value. A book value is the difference between a company’s total assets and total liabilities, which represents the net asset value (NAV) of the company. The formula for book value EPS is:

Book value EPS = (Total Equity – Preferred Equity) / Weighted average common shares outstanding

What is the Importance of Earnings Per Share?

Earnings per share are important for investors by offering a deep insight into a company’s profitability.

• Profitability Analysis

If the EPS is higher, it may signify greater profitability, which means the company’s stock is more appealing to investors and is higher in valuations.

• Price Determination

EPS helps to determine a company’s stock price. Stocks with higher EPS typically show higher prices in the market.

• Comparison

You can also compare the profits of different companies using the EPS. However, you should use EPS with other financial indicators to understand a company’s financial well-being.

Using the PL Capital application, you can also compare the profitability of different companies by analysing their EPS before buying a stock.

How is EPS Used in Valuation?

Earnings per share are a key indicator of a company’s profitability. It shows how much money a company makes for each share of its stock. EPS is significant in determining the Price-to-Earnings (P/E) ratio, which helps investors understand how much they are paying for each rupee of a company’s profits.

Investors may determine if a stock is reasonably valued given its earnings by dividing the company’s share price by its EPS.

While EPS is a valuable metric for buying stocks, it is not always significant on its own because regular shareholders do not immediately access the earnings. Rather, investors analyse the stock’s value and future growth possibilities by comparing EPS with the share price.

What are the Limitations of Earnings Per Share?

Although earnings per share shed light on a company’s profitability, there are also some drawbacks, which you must know:

• Manipulative

Most companies manipulate the EPS frequently to show their business is profitable. However, such attempts can result in short-term success, and often hamper its reputation and profitability in the long run.

• Overlooks Cashflow

Cash flow is a crucial figure which helps to measure the ability to repay debt of a company. However, EPS calculation does not feature cash flow. As a result, a high EPS may still be ineffective in measuring a company’s solvency.

• Misleading Value

The calculation of EPS also does not consider inflation. This, in turn, can make the growth indicated by it inaccurate. For example, inflation increases the overall price of goods and services. As a result, if the company fails to buy and sell more goods compared to what it did a year ago, a misleading EPS value can appear.

Final Thoughts

Earnings per share are one of the most crucial metrics when it comes to analysing a company’s profitability per share. You can calculate it by simply subtracting preferred dividends from the net profit of a company, and dividing that result by the total common shares outstanding.

However, you must check other important factors along with the EPS before judging the profitability of a company.

You can invest in stocks and analyse the key financial ratios of each company using PL Capital’s trading platform. PL also allows you to open a Demat account for free.

Frequently Asked Questions

1. What does an EPS show?

Earnings per share are a metric of a company’s profitability, which signifies a company’s profitability and its value to investors.

2. How to calculate a diluted EPS?

You can calculate a diluted EPS by dividing the net income of a company by its current shares outstanding, and adding the outcome with exercisable rights on new shares.

3. Is a higher EPS always good?

Yes, a higher or rising earnings per share is good since it suggests strong profitability. However, you should also consider the other financial indicators as well.

4. How is an EPS different from a dividend?

The difference between an EPS and a dividend is that EPS measures a company’s total profitability for each share, and dividends are the particular cash portion of those earnings which is paid out to shareholders.