Earnings Per Share

WHAT IS THE DEFINITION OF EARNINGS PER SHARE?

Earnings per share are the net earnings of the company earned on one share. It is an important and widely used metric which is even mentioned in the audited financial reports of the companies in most countries. In other words, it expresses the earning capacity of the company if divided by value of one share. We commonly call it return on equity. Higher the EPS, the better is the performance and prospects of the company. The track record of EPS for several years reflects the growth rate of the company and potential investors look forward to invest in the company if they see an increasing trend.

FORMULA FOR CALCULATING EARNINGS PER SHARE:

The equation or formula used for earnings per share ratio is as follows.

Earning Per Share = Profits / Earnings after Taxes (EAT) Less Preference Share Dividend
Number of Equity Shares Outstanding

Earning Per Share

Profits / Earnings after Taxes less Preference Share Dividend

The steps to calculate profits / earnings after taxes less after deducting preference share dividend (also known as the profit available for equity shareholders whether distributed as dividend or not) is as follows:
1.    Net Profit: Take the net profit / loss for the year from the profit and loss account of the company. Audit financials are preferred because it ensures proper compliances of all accounting standards and generally accepted accounting principles. Net profit here means profit arrived after deducting taxes. The tax rate would be different for different countries as per respective laws.
2.    Deduct Preference Share Dividend: In regard to preference shares, the dividend for cumulative preference shares will be deducted even if it is not provided, but for non-cumulative preference shares, the dividend shall be deducted only when it is provided.

A number of Equity Shares Outstanding

The no. of existing equity shareholders is taken. If the number of equity shares changes in the financial period, a weighted average of equity shares is calculated. Weights shall be given according to the no. of days or months outstanding during the year. Let us understand this with the help of an example.

EARNINGS PER SHARE EXAMPLE

Following are the Particulars of A Ltd for the purpose of calculating EPS.

Date Particulars Increase Decrease Balance
01.04.2013 No. of shares     18000
01.09.2013 Conversion of preference shares to equity shares 6000   24000
01.02.2014 Buy Back of shares   3000 21000

The profit before tax of the company is: Rs. 3, 50,000. Tax Rate 30%, Preference share dividend Rs.10,000.
With above facts, let us calculate EPS for the year.

For numerator part:

Profit before Tax

3,50,000

Less: tax 30%

1,05,000

P A T

2,45,000

Less: Preference Share Dividend

10,000

Net Profit

2,35,000

(Profit available for equity shareholders)

For denominator part:
Weighted average no. of shares= (18,000*5/12) + (24,000*5/12) + (21,000*2/12) = 21,000 Shares

Therefore, EPS = 2,35,000/21,000 = 11.19

DILUTED EARNING PER SHARE

Diluted EPS is EPS calculated after assuming that all convertible securities are converted. Convertible securities such as employee stock option, convertible preference share, convertible debentures etc. It is the EPS after giving the effect of such securities on both numerator and denominator of the EPS. The numerator will be increased by the amount of dividend or interest which will not be paid in the event of conversion of such securities. The denominator will be increased by the no. of equity shares issues as a result of such conversion.
So, the formula becomes

Diluted Earnings Per Share

=

EAT – Pref. Dividend + Expenses Saved Due to Conversion of Potential Equity Shares

Weighted Average No. of Equity Shares + Weighted Average No. of Converted Equity Shares

ADJUSTED EARNINGS PER SHARE

Adjusted Earnings per Share is the ratio of net profit from regular activities available to equity shareholders. It does not take effect of the following:
1.    Extra Ordinary Items: Items which occur suddenly without any prior notice such as windmill gain, or loss from natural calamities etc
2.    Non-Regular Activities: Activities which are not part of the day to day operations of the company such as the sale of assets, loss due to fire etc.
Adjusted EPS especially serves the purpose of Intra Company and Intercompany comparisons.

NEGATIVE EARNING PER SHARE

Sometimes companies incur losses i.e. negative earnings, which makes the EPS negative. Negative EPS reflects how much money the company has lost per share. The shareholders do not have to pay the share of loss to the company directly, but they suffer in an indirect way. The net loss decreases the value of the firm which in turn decreases the value of the shares. Negative EPS is not always a reason to panic. Sometimes it is a good sign as well. Like for example, when a company develops new products, or when it incurs the one-time big expense, then the negative EPS for a certain period is a temporary phenomenon.

INTERPRETATION / ANALYSIS OF EARNING PER SHARE

Earnings per share are most frequently quoted in financial statements and a very reliable figure for investors. It is useful for existing and new equity shareholders for forecasting the value of the shares in future. A high EPS is a sign of better earnings, strong financial position and therefore a reliable company to invest in. The EPS for several years indicates the growth pattern of the company. It also helps in comparison of figures of different companies in the same industry.

References:

Last updated on : August 31st, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Cash Ratio
  • DuPont Analysis
    DuPont Analysis
  • Interest Service Coverage Ratio /Times Interest Earned
    Interest Service Coverage Ratio / Times Interest …
  • Issue of Company Debentures
    Issue of Company Debentures
  • Profitability Ratios Chart
    Profitability Ratios
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook


    Related pages


    debt servicing coverage ratiostrategic motives for mergers and acquisitionswhat is pledge and hypothecationproject management npvwhat are some examples of variable expenseswhat is the meaning of current liabilitieswhat is debentures and bondsirredeemable debtnpv valuesdcf valuation formuladisadvantages of financial accountingexample of variable expensesadvantages and disadvantages of activity based budgetingexplain zero based budgetingdebits and credits rulesdebts to assets ratio formulafinance lease operating leaseinterest revenue on income statementdisadvantages of double entry systemdifferences between cash and accrual accountingfeatures of bill of ladingdebtors ratio definitionthe contribution margin per unit is equal to theytm in financedefine overdrafthow does invoice discounting workcallable debtirrevocable documentary creditcash vs accrualbep analysisportfolio management cfa level 1wacc wikiwealth maximisationstakeholders vs shareholdersrent expense journal entrywhat is retained profitbreak even sales volume formulawhat is meant by hypothecationirr benefitsoperating lease and capital leasecvp analysis advantagesreturn on capital employed calculationnpv meaningdefinition of waccprofitability index calculation exampleytm formulagordon model of dividend policyfixed cost and variable cost in accountingdefine accounting equationdisadvantages of debt financingfund flow analysis in financial managementcash payback methodirr examplewhat is bond and debenturepreference shares fixed dividendnaked mortgagesdifference between cost of capital and waccdividend growth formulafinancial accounting versus managerial accountingdefine cost behaviorbudgeting techniqueimportance of operating leveragegordon growth model derivationaccounting eqautioncapital budgeting and investment analysisq tobinwhat is operating lease and finance leasedisadvantages of financial statementscalculating pre tax cost of debtdifference between bill of exchange and bill of ladingthe payback methoddefinition of horizontal mergerhire purchase business definitionmeaning of hypothecationhow do you calculate inventory turns