What is Earnings Per Share?
EPS is the per share profit by a business
in a given period. While analysing a business
financially, it serves as one of the basic
tools. EPS is calculated by dividing profits
by total shares outstanding for a given period.
EPS is reported on the profit and loss statement
of an enterprise and works as a denominator
for beloved price-to-earnings ratio (P/E ratio),
used not just by novice investors but also
fund managers. A business is required to generate
sustainable earnings in its life cycle, and
earnings or profits are essentially among
major intend of a promotor.
But reported earnings of a business will likely
differ from actual cash earnings because devising
profits mandate broader accounting standards
and principles to provide a fair picture of
an enterprise. EPS, therefore, becomes imperative
for investors, market participants and other
users of information.
EPS estimates are circulated by sell-side
analysts to market participants. Financial
Modelling is applied to arrive at the EPS
estimates of future financial years, semi-annual
periods or quarterly, depending on the reporting
adopted by the firm.
Analyst estimates are then collected by market
data providers like Reuters, Bloomberg, IRESS
to provide a consensus view of analysts on
the business and its financials, including
revenue, operating expense, earnings before
interest and tax, profit after tax, EPS.
Market estimates enable participants to evaluate
the expectations of sell-side analysts from
a particular company, sector or even index.
Analyst estimates also indicate the divergence
between an individual’s expectations and
collective expectations of analysts that are
tracking the company.
An individual can, therefore, determine whether
the stock of the company is undervalued or
overpriced by the market against hi one’s
fair value estimates that are based on the
expectations from the company.
How to calculate EPS?
Although general formula considers total shares
outstanding in the denominator, it is preferred
to use weighted average shares outstanding
over a period because companies issue new
shares, buyback or cancel shares.
Net Income is the profit reported by a business
after incurring income tax. It is also called
as Net Profit After Tax.
Dividends on Preferred Shares are paid to
preferential shareholders because they have
first right over the income of a business,
but preferred shares don’t have voting rights
like common shareholders or ordinary shareholders.
Weighted Average Shares Outstanding is calculated
after incorporating changes in number of shares
during a period, and using weighted average
shares outstanding provides a fair financial
position of a company.
Basic V/S Diluted EPS
Diluted EPS is calculated after adding the
weighted average number of shares that would
be issued after the conversion of dilutive
shares to weighted average shares outstanding.
Dilutions can include share rights, performance
rights, convertible bonds etc.
Whereas Basic EPS is calculated by taking
weighted average shares outstanding that incorporate
changes to number of shares outstanding such
as buyback, new issues etc.
What is Adjusted-EPS?
In a financial period, firms may incur one-time
expenses or transactions that are not usual
in the normal course of business. The objective
of adjusted EPS is to arrive at a fair picture
of the business, especially for financial
forecasting.
Extraordinary items are excluding from EPS
to arrive at adjusted EPS figure. These items
can include gain on sale of assets, loss on
sale of assets, merger costs, capital raising
costs, integration expenses etc.
What is Normalised EPS?
Normalised EPS is calculated to arrive at
an EPS figure, which embeds the fluctuations
in income due to business cycles or industry
cycles. It also includes adjustments made
for calculation of adjusted EPS such as one-time
gains or losses.
Normalised EPS is a useful measure for companies
that are sensitive to economic cycles or changes
in the business environment. By smoothening
out the fluctuations, it provides a fair picture
of the business.
If a company has reported high normalised
earnings over periods, it is considered that
the company is less sensitive to changes in
business cycles because of its stable revenues
and income during the periods.
EPS and Price-to-earnings ratio
Calculation of price-to-earnings ratio requires
EPS as denominator and price of the stock
as numerator. EPS therefore becomes a very
important financial metric for investors.
EPS and price data also allows participants
to compare the historical trends of the P/E
ratio with the current market scenario and
P/E ratio of the stock.
How can increase grow EPS?
Businesses can increase EPS by focusing on
increasing their revenue, by improving operational
efficiencies either by deploying technology
to reduce cost, or negotiate better prices
with vendors, operate in tax efficient manner,
etc. Businesses can also improve EPS by undertaking
corporate action such as buying back of shares.
