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 that audited financial reports of the companies also particularly mentioned in most countries. In other words, it expresses the company’s earning capacity if divided by the value of one share. We commonly call it return on equity. The higher the EPS, the better the company’s performance and prospects. The track record of EPS for several years reflects the company’s growth rate, and potential investors look forward to investing in the company if they see an increasing trend.
Formula for Calculating Earnings Per Share
The equation or formula used for the earnings per share ratio is as follows.
|Earnings Per Share = (Profits or Earnings after Taxes (EAT) – Preference Share Dividend) / Number of Equity Shares Outstanding|
For detailed reading, you can refer How to Calculate EPS?
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 a dividend or not) is as follows:
- Net Profit: Take the net profit/loss for the year from the profit and loss account of the company. Audited financials are preferred because they ensure compliance with 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.
- 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. A weighted average of equity shares is calculated if the number of equity shares changes in the financial period. Weights are given according to the no. of days or months outstanding during the year. Let us understand this with the help of an example.
You can use our EPS CALCULATOR for calculations.
Earnings Per Share Example
Following are the Particulars of A Ltd to calculate EPS.
|01.04.2013||No. of Shares||18000|
|01.09.2013||Conversion of preference shares to equity shares||6000||24000|
|01.02.2014||Buyback 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 the above facts, let us calculate EPS for the year.
For the numerator part:
|Profit before Tax||3,50,000|
|Less: Tax @ 30%||1,05,000|
|Less: Preference Share Dividend||10,000|
|(Profit available for Equity Shareholders)|
For the 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 Earnings Per Share
After assuming that all convertible securities have already converted into equity, Diluted EPS is the EPS. Convertible securities such as employee stock options, convertible preference shares, convertible debentures, etc. It is the EPS after giving the effect of such securities on both the numerator and denominator of the EPS. The numerator increases by the amount of dividend or interest which is not paid in the event of conversion of such securities. The denominator increases by the no. of equity shares issued due to such conversion.
So, the formula becomes
|Diluted EPS = (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)|
Read more at Basic vs Dilutes EPS
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 on the following:
- Extra Ordinary Items: Items that occur suddenly without any prior notice, such as windmill gain, or loss from natural calamities, etc
- Non-Regular Activities: Activities that 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 Inter-company comparisons.
What is a Good EPS? – read here
Negative Earnings Per Share
Sometimes companies incur losses, i.e., negative earnings, making 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 the loss to the company directly, but they suffer indirectly. The net loss decreases the firm’s value, which in turn reduces the value of the shares. Negative EPS is not always a reason to panic. Sometimes it is a good sign as well. For example, when a company develops new products or when it incurs a one-time big expense, then the negative EPS for a certain period is a temporary phenomenon.
Interpretation / Analysis of Earnings Per Share
Earnings per share are most frequently present in financial statements and are a very reliable figure for investors. It is useful for existing and new equity shareholders for forecasting the value of the shares in the future. A high EPS is a sign of better earnings, a 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 compare figures of different companies in the same industry.
Read more about RETURN ON EQUITY.