To put it in simple language, earnings per share is the value of earnings per outstanding share of a company. Let’s break it down further. If a company is to distribute all its profits amongst the shareholders then the amount receivable by the shareholders per share is the earnings per share.
How to calculate EPS:
Now, since preference shares are held above the common share as the names suggest, dividends payable to the preference shareholders is subtracted from the profits of the company. The amount that we have arrived at is divided by the weighted average number of outstanding shares.
Now let’s understand what we mean by weighted average number of outstanding shares through an example. A company ABC, in its first year of listing their stocks in the market issues shares as below in the financial year 2017-18.
1st issue – 10,000 shares on April 1, 2017
2nd issue – 5,000 shares on October 1, 2017
3rd issue – 6,000 shares on January 1, 2018
The weighted average of the outstanding shares will be calculated as below.
10,000 shares were outstanding for the whole year (12/12). Hence, from the first issue – 10,000
5,000 shares were outstanding for only half the year (6/12). Hence, from the second issue – 2500
6,000 shares were outstanding for only 3 months (3/12). Hence, from the third issue – 1500
Hence, the weighted average number of outstanding shares for the financial year 2017-18 for company ABC is 14,000. Let’s say the company’s profit figure after deducting tax and dividend is INR 98,000.00, the earnings per share of the company would be INR 12.00
Importance of EPS in analysis of investment opportunities:
Now we come to the part where EPS helps us in analysis of a company. A major flaw with this ratio is that it does not take the market value (stock price) of the share into account. It doesn’t make the ratio useless nonetheless.
You can compare the ratio historically i.e compare the EPS figure of the current year with that of the last year. If it’s higher, it indicates that the company has made more profits as compared to the last year and vice-versa.
You can compare the ratio with the anticipated growth / expected returns of a company of the next year with the current year and if it’s higher, it indicates that the company will make more profits as compared to the current year and vice-versa.
You can also compare the EPS of a company with a competitor’s EPS in the same industry. However, this comparison will only be useful if the market value of both the shares is the same which is never the case in reality. Hence, this way of comparison is not advisable.