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What is Earnings Per Share (EPS)?
The monetary value of an organization’s earnings per outstanding share of common stock is known as earnings per share. It is a crucial indicator of organizational profitability and is frequently applied to stock pricing.
A company’s quarterly or annual profit is divided by the total number of outstanding shares of stock to get its earnings per share (EPS). It serves as the main benchmark for evaluating the profitability of a business. Higher EPS values are typically thought to indicate more profitable companies.
EPS assist investors in determining, among other things, if the firm they are researching is a good investment at the going rate.
How is EPS Calculated?
EPS is found by taking the net income of a company and subtracting the preferred dividends. This number is then multiplied by the total number of outstanding shares of stock.
The formula for EPS is as follows:
EPS = [(Net Income-Preferred Dividends)/Outstanding Common Shares].
Suppose a company’s quarterly net income is Rs. 1 crore. The company has 20 lakh equity shares that are still in circulation and pays preferred dividends of Rs. 10 lakh on its preference share capital.
EPS = [(1,00,00,000-10,00,000)/20,00,000]
EPS equals 4.5 rupees per share.
Most of the time, the weighted average of common shares is used to figure out EPS because the number of outstanding common shares can change a lot over a certain time period.
How is EPS Used?
One of the most crucial metrics used to assess a company’s profitability on an absolute basis is earnings per share. EPS plays a significant role in determining the price-to-earnings (P/E) ratio, where the EPS is the “E” in P/E.
An investor can determine the value of a stock in terms of how much the market is willing to pay for each rupee of earnings by dividing a company’s share price by its earnings per share.
Because common shareholders do not have direct access to the earnings, comparing EPS in absolute terms may not mean much to investors. Instead, to assess the value of earnings and how confident they are in future growth, investors will contrast EPS with the stock’s share price.
Five (5) Importance of EPS:
The following points highlight the significance of earnings per share in terms of gauging a company’s financial health and profitability.
- EPS can also be used to compare a company’s financial performance over time.
- Earnings per share (EPS) help keep track of a company’s past performance and measure its current financial situation.
- It helps choose the best investment option by letting you compare how well different businesses have done.
- Companies with consistent EPS growth can make safe investment choices. In contrast, seasoned investors typically do not like a company’s volatile EPS movements.
- Since a higher EPS means a company is making more money, it is possible that the company will eventually raise dividends.
Limitations of EPS:
Even while earnings per share (EPS) is regarded as a potent financial instrument, one must keep in mind that EPS has a number of disadvantages. The following restrictions should be kept in mind by both business owners and investors:
- Measuring a company’s ability to pay off its debt requires taking into account its cash flow. But since cash flow isn’t taken into account when EPS is calculated, a high EPS may not be a good way to figure out if a company can stay in business.
- The majority of business owners adjust the EPS to make the company appear more profitable. Most of these attempts, though, are short-term, which often hurts a company’s long-term reputation.
Types of EPS:
There are Five (5) Types of EPS. The following are as follows;
Reported EPS, also known as GAAP EPS (Generally Accepted Accounting Principles), is arrived at when the profit of a corporation is divided by the number of outstanding shares of its common stock to arrive at earnings per share (EPS).
Business must report their net earnings to their various Stakeholders. And, when such reporting, the final earnings available for the equity shareholders for their investments made is called reported EPS. Businesses usually report EPS that has been changed to account for unusual costs and possible share dilution.
Book Value EPS
Book value or carry value EPS is the true cash value of each share of a company’s stock, which is its EPS. The real total amount of money earned is the cash EPS.
It is used to determine the average equity in each share of a corporation. If the company is liquidated, book value EPS can be used to calculate the entire investment value. Because it is based on the balance sheet, this EPS gives a fixed picture of how well the company is doing.
Financial performance measures that compare cash flow to the number of outstanding shares are known as cash earnings per share (cash EPS) or operating cash flow, respectively. Earnings per share (EPS), which looks at net income per share and is a more common way to measure net profit, is different from cash EPS.
Cash EPS is used to evaluate a company’s financial position. It is frequently used to determine the precise amount of income a company generates. Investors rely on cash EPS for stock analysis because it might be difficult for corporations to manipulate this EPS.
The earnings retained by the corporation as opposed to being distributed as dividends are known as retained EPS. The real total amount of money earned is the cash EPS.
It is typical for businesses to keep their profits rather than distribute them to investors in the form of dividends. The profits are put to good use for things like debt repayment and business expansion. In these situations, retained EPS is used.
Pro forma or ongoing EPS removes income reported as extraordinary one-time income but uses ordinary net income for calculation. So, it helps figure out how much a company can expect to make from its main business activities.
Regular EPS excludes anything that might be regarded as an unusual one-time event because it is based on ordinary net income. Since identifying the stream of earnings from core businesses is the main objective, current EPS serves as a pretty trustworthy predictor of future EPS.
One of the most popular and useful methods for examining a company’s financial performance is to look at its earnings per share. It can be used with other measures to figure out how healthy a company’s finances are overall and if it would be a good investment to add to your portfolio.
If you’re just getting started with fundamental analysis, EPS merits all of your focus because it will make the process more transparent and accurate. But, EPS isn’t the only metric used to evaluate a stock. In fact, stock investing is a task that demands a vast amount of research.
Hence, it would also be beneficial if you thought about getting professional advice if you’re new to the stock market and want to create a long-term stock portfolio. because
Disclaimer: All the information on this website is published in good faith and for general information purposes only.