Calculating profit margins is not enough in order to invest in a company. You have to analyse the company from all steps in order to know whether the stock is a good investment for you. One of such factors is earnings per share or EPS. It’s reported in the income statement to tell you how much the earning company generates per share outstanding.
Earnings per share or EPS is calculated by dividing net earnings of the company by the average number of stocks outstanding. It basically tells you how much of a slice of company’s net earnings you are entitled to as a shareholder.
Earnings Per Share is a very good comparison toll as comparing earnings of one company to another really doesn’t make any sense. EPS has much importance to people who invest in the stock market.
Earnings Per Share or EPS = Company’s Net profit / Number of Outstanding Shares
Company’s net profit or income as it’s used in the above formula is defined as the sum of all revenues less expenses, including operating, selling, administrative, other expenses, depreciation, interest, taxes, and dividends paid to preferred stockholders.
EPS measures the amount of net income or profit earned per share of stock outstanding. In other words, EPS represents a portion of a company’s profit that is allocated to one share of stock.
This means, EPS will indicate the amount of profit each investor will receive in proportion to their holdings if all the profits were distributed among them at the end of the year.
For instance, suppose that company X and Y earns 1, 00,000 rupees each but company X has 1, 000 shares outstanding, while company Y has 500. In this case owners of company Y will be benefited more in comparison to company X as earnings per share is more.
Example to calculate Earnings Per Share or EPS
Company A sold 100,000 units during the year, resulting in a net profit of Rs 250,000. The stockholders of the company are entitled to distribute this profit among themselves. If the company has 250,000 outstanding shares then distributing the entire profit among stockholders means that each share will have a profit of Rs 1. This calculation is called earnings per share or EPS.
If next year, the company has a net profit of Rs. 1,000,000, the earnings per share would be Rs.4 (I.e. Rs. 1,000,000 divided by 250,000).
EPS or earnings per share measures the amount of return per share to the equity owners of a company. For this reason, it’s always a good idea to look for earnings per share or EPS of a company before investing. You can find all this information in a company’s financial statements as it’s a must for companies to disclose.
If the company has decided to pay a dividend then net earnings should be taken by subtracting preferred dividends. Preferred dividend is an amount of money that is paid out to preferred stockholders by the company during the year from company’s profit. The reason for this subtraction is to measure the income available to common stockholders.
Many times you will find weighted average common shares used in the EPS calculation. This happens as companies often issue new stocks or buy back their own stock throughout the year. Weighted average of common shares can be calculated by adding the beginning and ending outstanding stocks and dividing it by two.
When calculating Earnings Per Share, it will be more accurate if weighted average number of stocks outstanding is used in the denominator, because the number of stocks outstanding can change over time.
Earnings Per Share or EPS = (Net Income – Dividends on Preferred Stock)/ weighted average Outstanding shares
Assume that company Z has a net income of 25, 000 rupees. If the company has paid 1, 000 in dividends and has 10, 000 stocks for half of the year and 15, 000 stocks of the other half, EPS would be calculated as follows;
Earnings Per Share or EPS = (25, 000 – 1,000)/ {(10,000+15,000)/2} = 24,000/12500 = 1.92
In the above calculation we have deducted 1,000 dividends from the net income of 25,000 to get 24, 000 for EPS calculation. For weighted average outstanding shares we have added 10, 000 and 15,000 which is then divided by 2 to get 12500.
EPS focuses on the portion of net earnings that is applicable to a single share of common stock. If the company has only equity shares, basic EPS has to be calculated. In case of a complex capital structure, where it includes convertible bonds and preferred stocks, the company reports both basic and diluted EPS. Both diluted and basic earnings per share or EPS present on the face of the income statement.
Also Read: What is diluted earnings per share
