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What is Earnings Per Share? Why EPS is Important? Research Team | Posted On Monday, January 13,2020, 12:27 PM

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What is Earnings Per Share? Why EPS is Important?



Earnings per share is an important terminology for investors and traders who trade in the stock markets. It is an indication of the profitability of a firm. Higher the EPS, the better is the profitability of the firm. Before buying the shares of a company, the EPS of the company is analyzed. It is an important variable that determines the financial strength of a company.

What are Earnings Per Share?

The profits of a company are allocated to each share in the form of EPS. The total income of a company divided by a number of outstanding shares gives the earnings per share. It is also called net income earned per share. In other words, if all the profits earned were to be distributed to each outstanding share at the end of the year, this amount distributed would be termed as Earnings per share or EPS.

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What are Earnings Per Share? Why EPS is Important?

The Formula for Calculating Earnings Per Share

EPS = Profit After Tax – Preferred Dividend / Number of outstanding subscribers.

Preferred dividends are cash paid to the company’s preferred shareowners. The preferred shareowners are paid out before the common shareholders. The total number of outstanding shares of a company keeps changing. The company may issue new shares, repurchase shares, retire existing shares and so on. The weighted average is a measure that takes into account all these changes and calculates important financial measures for a particular period.

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Calculation of Earnings Per Share

For the calculation of EPS, the financial statements of a firm must be known. Profit after Tax and preferred dividends if there exists any, can be fetched from the income statement. The number of outstanding shares can be found in the balance sheet. Stockholder’s equity section will reveal the number of shares outstanding.

Significance of Earnings Per Share

  • It is important to calculate EPS, as it indicates the profitability of a firm. The number of outstanding shares of a company might change over the years. So-net income cannot be used as a tool to measure profitability. Whereas EPS serves the purpose.
  • Valuation metrics are measures of a company’s financial health. It includes P/E ratio and other metrics. EPS can be used to calculate the price-to-earnings ratio which is an important factor to compare stocks. This comparison can be with the company’s historical values, companies in the same industry and so on.

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Types of EPS

There are three types of EPS:

  • Trailing EPS: This EPS is calculated on the basis of previous numbers. It takes into consideration the previous four quarters' values in its calculation. It is based on real past data, and not on assumptions. However, since it is history and not current happening, some investors might ignore this value.
  • Current EPS: This EPS is calculated on the basis of the current year’s quarter values. Some of them would be real data, and the rest would be assumptions. Hence it is a combination of real and projected values.
  • Forward EPS: A forward EPS is based on projections for the next four quarters. This is often calculated by analysts or the company itself. Although these are not real values, investors are interested in forwarding EPS, as it indicates the future earning potential of a company.

What are Diluted Earnings Per Share?

Diluted EPS is a financial figure that measures the income that each share would earn if all the dilutive securities are realized. Dilutive securities are those that have the potential to be converted to common shares. Examples of dilutive securities are bonds, preferred shares and so on.

Diluted EPS is more detailed than EPS. It influences a firm’s P/E ratio and other measures. The following figures are a must to calculate the diluted EPS: Net income after tax, preferred dividends, the convertible preferred dividends, the convertible debts, the tax rate, the weighted average of dilutive common shares, unexercised employee stock options. The diluted EPS will be a lower value compared to EPS.

Calculation of diluted EPS exhibits the future of a company if all stock options and conversions were converted to common shares. This is an informative value to investors and creditors. They can realize the true capacity of a firm’s finances. It is calculated in a similar way to EPS calculations. Dilutive securities are added to common shares in the denominator.​

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1. EPS:  A company XYZ has a net income – tax of Rs 10 Lakh for the last fiscal year. They have no preferred shares. The number of outstanding common shares is Rs 1 Lakh.

Therefore, EPS = 10,00,000 / 1,00,000= Rs 10 per share.

2. Diluted EPS: The same company has an additional stock option, which can be converted to Rs 3 Lakh common shares. In this case,

Diluted EPS= 10,00,000 / (1,00,000+3,00,000) = Rs 2.5 per share.

This shows that diluted EPS is always lower than EPS, if a company has dilutive securities.

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