If you're thinking about investing in the stock market, you might have come across the term Earnings Per Share (EPS). It is one of the key metrics investors use to evaluate a company's performance. EPS helps you understand how much profit a company is generating for each share of stock. Let’s break down what EPS is, how it works, and why it’s important for investors.

What is Earnings Per Share (EPS)?

Earnings Per Share (EPS) is a financial metric that shows how much profit a company has made for each share of its stock. It is calculated by dividing the company’s net income (profits after all expenses, taxes, and interest) by the total number of outstanding shares. EPS helps investors understand how much profit the company is making for every share they own. A higher EPS generally means that the company is doing well and is profitable.

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Earnings Per Share Equation

The formula for calculating EPS is very simple:

EPS=Net IncomeOutstanding Shares\text{EPS} = \frac{\text{Net Income}}{\text{Outstanding Shares}}EPS=Outstanding SharesNet Income​

• Net Income: This is the company’s profit after all expenses, taxes, and interest are subtracted.

• Outstanding Shares: This is the total number of shares of the company that are currently available for trading.

So, for example, if a company has net income of ₹10,000 and there are 1,000 outstanding shares, the EPS will be ₹10.

What Does Earnings Per Share (EPS) Indicate?

EPS is an important indicator of a company's profitability. A higher EPS means the company is making more profit for each share, which could mean the company is performing well. If the EPS is low or negative, it might indicate that the company is not making enough money or is facing losses.

Investors usually look at EPS growth over time. If EPS is growing year over year, it may indicate that the company is improving its performance, which could be a good sign for investors.

What is Weighted Average Number of Outstanding Common Shares?

When calculating EPS, the weighted average number of outstanding shares is used. This is because the number of shares in the market can change over time due to stock buybacks, stock splits, or new shares being issued. The weighted average accounts for these changes over the period for which the EPS is being calculated.

For example, if a company had 1,000 shares at the start of the year and issued 500 more shares midway through the year, the weighted average would give more importance to the shares that were in circulation for a longer time.

Types of Earnings Per Share

Earnings Per Share (EPS) is a key indicator used by investors to assess a company’s profitability. While Basic EPS and Diluted EPS are the most common, other types of EPS give more specific insights into a company’s performance. Below, we explore all types of EPS in detail:

1. Basic EPS

• What It Is: Basic EPS calculates a company’s profit per share based on the total number of outstanding shares during a particular period.

• How It Works: Basic EPS is calculated by dividing the company’s net income by the weighted average number of outstanding shares during the period.

  Formula:  Basic EPS=Net Income/ Weighted Average Shares Outstanding

• Usage: Basic EPS is used to measure a company’s performance using the existing number of shares, without considering the potential dilution from stock options, warrants, or other convertible securities.

2. Diluted EPS

• What It Is: Diluted EPS accounts for the potential dilution that could happen if all outstanding convertible securities (like stock options, convertible bonds, etc.) were converted into common shares.

• How It Works: The calculation includes not only the current number of shares but also the number of shares that could be created by the conversion of all dilutive securities.

  Formula: Diluted EPS = Net Income/Weighted Average Shares Outstanding + Convertible Securities

• Usage: Diluted EPS gives a more conservative and realistic view of a company's earnings per share, considering the impact of future conversions or dilutions.

3. Adjusted EPS

• What It Is: Adjusted EPS excludes non-recurring items, extraordinary expenses, or gains, giving a clearer view of the company's core earnings.

• How It Works: Companies often report adjusted EPS to remove the effects of one-time events like asset sales, restructuring costs, or other special items that can distort a company’s actual financial performance.

  Formula: Adjusted EPS = Net Income- Non-recurring Items/ Weighted Average Shares Outstanding

• Usage: Adjusted EPS helps investors focus on the company's ongoing performance by ignoring items that are unlikely to recur.

4. Pro Forma EPS

• What It Is: Pro Forma EPS is calculated by adjusting the earnings to reflect a hypothetical situation, like an acquisition or restructuring, and removing any one-time costs.

• How It Works: It gives a clearer picture of how a company's earnings would look if certain changes were made to the company's structure or operations.

  Formula: Pro Forma EPS = Adjusted Net Income/ Adjusted Shares Outstanding

• Usage: Pro Forma EPS is often used to show a company’s potential performance after a significant corporate event.

5. Trailing Twelve Months (TTM) EPS

• What It Is: Trailing Twelve Months (TTM) EPS is calculated using the company’s earnings over the past 12 months rather than a single fiscal year.

• How It Works: TTM EPS is used to evaluate a company’s current performance by considering the most recent four quarters of earnings data, providing an up-to-date snapshot of the company’s profitability.

  Formula: TTM EPS=Earnings for the Last 12 Months/Shares Outstanding in the Last 12 Months

• Usage: TTM EPS is useful when comparing a company’s earnings to its competitors, especially when the company has had irregular quarterly performance.

6. Forward EPS

• What It Is: Forward EPS refers to the projected or estimated EPS for the upcoming fiscal year, based on analysts' predictions.

• How It Works: Unlike the historical EPS, forward EPS is a forecast of future earnings, helping investors gauge how well the company is expected to perform in the upcoming year.

  Formula: Forward EPS = Projected Earnings for Next Year/Estimated Shares Outstanding

• Usage: Forward EPS is typically used by investors to make predictions about future profitability and to compare it to the current stock price to determine if a stock is undervalued or overvalued.

7. Cash EPS

• What It Is: Cash EPS focuses on cash flow rather than net income. It measures how much cash the company generates per share.

• How It Works: Cash EPS is useful because it shows the company’s ability to generate actual cash, which can be used for dividends, reinvestment, or debt repayment, rather than relying on accounting profits.

  Formula: Cash EPS = Operating Cash Flow/Weighted Average Shares Outstanding

• Usage: Cash EPS is useful for investors who want to focus on a company’s ability to generate cash rather than profits, which could be impacted by accounting choices.

Example of EPS (In Table Format)

In this table, Company A has an EPS of ₹10 because it earned ₹10,000 and has 1,000 shares. Company C, even though it earned ₹20,000, has an EPS of ₹5 because it has more shares (4,000).

What Is a Good Earnings Per Share Ratio?

A good EPS ratio depends on the industry and the company. Generally:

• A higher EPS indicates higher profitability, which is a good sign for investors.

• Growth in EPS over time is also a good indicator that a company is improving its profits.

However, EPS should be compared with companies within the same industry to get a more accurate idea. An EPS of ₹10 in a tech company might be great, while ₹10 in a utility company might be average.

Why EPS Matters to Investors - Importance of Earnings Per Share

EPS is important because it gives investors a clear picture of a company’s ability to make profits. It helps in:

1. Assessing Profitability: EPS shows how much profit a company generates for each share.

2. Comparing Companies: Investors use EPS to compare companies within the same industry.

3. Valuation: A strong, growing EPS can increase a company's stock value, making it more attractive to investors.

4. Predicting Future Performance: If a company’s EPS is growing, it suggests that the company is on a good track, which could lead to better returns in the future.

Limitations of Earnings Per Share

While EPS is a helpful measure, it has some limitations:

1. Doesn’t Show Full Financial Picture: EPS only shows profits, but doesn’t include other important factors like cash flow.

2. Earnings Manipulation: Companies can sometimes manipulate earnings using accounting tricks, which can affect EPS.

3. No Insight Into Debt: EPS doesn’t show how much debt the company has, which can be important for understanding financial risk.

Diluted EPS vs. Basic EPS

As mentioned before:

• Basic EPS only uses the actual outstanding shares.

• Diluted EPS includes all potential shares that could be created from stock options, convertible bonds, etc.

Why is this important?

• Diluted EPS gives a more conservative estimate of the company’s earnings per share because it accounts for the potential increase in shares. If the diluted EPS is much lower than the basic EPS, it means the company could face dilution in the future, which could reduce the value of your shares.

Adjusted EPS vs. EPS

Adjusted EPS refers to the EPS calculated after excluding non-recurring items like one-time profits, losses, or extraordinary expenses. It gives a more accurate picture of a company’s core earnings.

• EPS: Includes all earnings, even one-time items.

• Adjusted EPS: Focuses on core earnings, excluding one-off items.

Why is it important?

• Adjusted EPS can give you a clearer idea of how the company is really performing without the influence of rare events.

EPS and Dividends

EPS and dividends are closely related. Companies that make more profit (higher EPS) are more likely to share those profits with shareholders in the form of dividends. However, companies can also choose to reinvest their profits rather than paying them out as dividends.

So, if a company has a high EPS, it could either pay higher dividends or reinvest that profit to grow further.

EPS and Price-to-Earnings (P/E)

EPS is closely linked to the Price-to-Earnings (P/E) ratio. The P/E ratio helps investors determine if a stock is overvalued or undervalued based on its EPS. It’s calculated as:

P/E Ratio=Stock PriceEPS\text{P/E Ratio} = \frac{\text{Stock Price}}{\text{EPS}}P/E Ratio=EPSStock Price​

A higher P/E ratio could indicate that investors expect high growth, while a lower P/E ratio could suggest that the stock is undervalued or the company is not growing as expected.

Earnings Per Share (EPS) is a critical metric for investors as it helps measure a company’s profitability and gives insights into how much profit the company generates for each share of stock. Understanding EPS, its types (basic vs. diluted), and its limitations can help you make better investment decisions. Whether you are looking for growth in earnings or comparing stocks, EPS is one of the best tools to assess a company’s performance.

Make sure to combine EPS with other financial metrics for a complete picture of the company’s financial health.

Here, all share convertibles include all kinds of securities such as bonds, debentures, and preference shares that can be converted to equity shares in the future.

Earnings Per Share - An Example

Now that you’re aware of how to calculate EPS, let’s take up a hypothetical example to better understand the calculation.

Assume there’s a company ‘LMN Limited’. The company’s net income for FY23 after accounting for expenses such as preferred dividends, interest payments, and taxes comes up to Rs. 98 lakhs. The weighted average number of outstanding shares is 65 lakhs. The company has also issued around 1 lakh convertible debentures, which will be converted to 5 lakh equity shares on maturity. Additionally, the company has also issued 5 lakh convertible preference shares, which will be converted to 10 lakh equity shares on maturity.

With this information on hand, let’s try to calculate both the basic and diluted Earnings Per Share metrics for the company.

As you can see, the basic EPS is higher than the diluted EPS due to the lower number of outstanding shares. The basic Earnings Per Share of Rs. 1.51 essentially means that shareholders would receive Rs. 1.51 for every equity share held by them if the company chooses to distribute the entire net income earned by it during FY23.

The Importance of Earnings Per Share

As you’ve already seen before, Earnings Per Share is a good way for investors to find out if a company is profitable enough. However, it would be imprudent to make investment decisions based solely on the EPS figure of a company.

For instance, a company’s basic EPS is let’s say Rs. 45. Going by this figure alone, you may think that the company is profitable and a worthy investment. But you won’t have any perspective of how the company fares against its rivals or the industry. Assume that the industry’s average EPS is around Rs. 70. Now, does the company’s EPS of Rs. 45 still look attractive? Obviously not.

That’s why it is always important to measure a company’s EPS with that of its rivals and the industry average. This way, you can get a better picture of the company’s profitability and make an informed decision about whether it is a good investment or not.

Conclusion

With this, you must now be aware of what EPS is and how to calculate it. Fortunately, almost all companies in India publish their basic and diluted EPS figures in their financial statements themselves, eliminating the need to manually calculate them.

That said, when using Earnings Per Share to determine a company’s worth, it is advisable to also consider the EPS growth rate over the years. Ideally, a company’s EPS should increase from year to year. If you find that the metric is fluctuating unpredictably or declining every year, you may want to think twice before investing in it.

Related reads: Do you understand the difference between basic and diluted EPS?

Frequently Asked Questions (FAQs) on Earnings Per Share (EPS)