Table of Contents
- 1 WHAT IS THE DEFINITION OF EARNINGS PER SHARE?
- 2 FORMULA FOR CALCULATING EARNINGS PER SHARE:
- 3 EARNINGS PER SHARE EXAMPLE
- 4 DILUTED EARNING PER SHARE
- 5 ADJUSTED EARNINGS PER SHARE
- 6 NEGATIVE EARNING PER SHARE
- 7 INTERPRETATION / ANALYSIS OF EARNING 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|
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.
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.
|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||
|Less: tax 30%||
|P A T||
|Less: Preference Share Dividend||
|(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.