What is EPS in Share Market
What is EPS in Share Market
Understanding EPS for Stock Investing
Earnings per share (EPS) can be described as the portion of a company’s profit allocated to each outstanding share of stock.
It is a key financial metric used to assess the financial performance of a company. A higher EPS indicates greater profitability and success in the company’s endeavors.
It serves as an indicator of the company’s overall financial health and its ability to generate earnings for its shareholders.
EPS Formula
EPS = (Net Income − Preferred Dividends)/End-of-Period Common Shares Outstanding
Earnings per share (EPS) can be computed using two methods:
1) Basic earnings per share: Net Income after Tax divided by the Total Number of Outstanding Shares.
2) Diluted earnings per share: (Net Income after Tax – Total Dividends) divided by the Total Number of Outstanding Shares.
The diluted earnings per share calculation takes into account convertible shares and warrants in addition to outstanding shares, providing a more comprehensive view of the ratio.
For investors seeking a consistent income stream, the EPS ratio can indicate the potential for a company to increase its current dividend. However, it is important to note that EPS should not be evaluated in isolation. Comparing a company’s EPS to that of other companies is crucial for making well-informed investment decisions.
Different Types of EPS
There are five different types of EPS:
Reported EPS or GAAP EPS
Reported EPS, also known as GAAP EPS, is calculated following the Generally Accepted Accounting Principles and is disclosed in SEC filings.
However, it’s important to note that GAAP can sometimes distort a company’s earnings. For example, if a one-time payment is treated as operating income under GAAP, it can artificially inflate the EPS.
Similarly, if a company categorizes regular expenses as unusual expenses, it can boost the earnings per share artificially.
Ongoing EPS or Pro Forma EPS
Ongoing EPS, or Pro Forma EPS, is based on the ordinary net income and excludes income that is typically considered unusual or one-time.
It provides a better understanding of the anticipated income from a company’s core business operations. However, it may not reflect the company’s true earnings.
Retained EPS
Retained EPS indicates that a company retains its profits instead of distributing them as dividends to shareholders.
Business owners often use retained earnings per share to address existing debts or for purposes like expansion or future requirements.
To calculate retained EPS, the net earnings are added to the current retained earnings and then the total dividends paid are subtracted. The result is divided by the total number of outstanding shares.
Cash EPS
Cash EPS provides insights into a company’s financial position by indicating the exact amount of cash earned. It is difficult to manipulate cash earnings per share.
The calculation for cash EPS involves dividing the operating cash flow by the diluted shares outstanding.
Book Value EPS
Book Value EPS is used to calculate the average equity amount in each share. It can be helpful in estimating the value of a company’s stake if it were to be liquidated.
Book Value EPS focuses on the balance sheet and provides a static representation of a company’s performance.
How Is EPS Used?
EPS serves multiple purposes, which include:
– EPS helps investors assess the potential income they could receive from investing in a company. A higher EPS indicates a more profitable company, which may result in a higher dividend payout for investors.
– EPS allows for comparisons of the performance of different companies, aiding in making informed investment decisions.
– EPS is a valuable metric for estimating the current and future stock value of a company. It helps evaluate if a company’s market performance justifies its stock price. For example, investors use EPS in the Price-Earnings Ratio formula (P/E) to calculate earnings (E).
– EPS not only reflects a company’s current financial situation but also provides insights into its historical performance. Investing in companies with a consistently increasing EPS is often seen as more reliable. Seasoned investors typically avoid companies with inconsistent or declining earnings per share.
Why is Earnings Per Share Very Important in Share Market
The importance of earnings per share (EPS) in measuring a company’s profitability and financial standing can be summarized as follows:
– EPS helps investors assess the potential income they can generate by investing in a company. A higher EPS indicates profitability, suggesting the company may increase its dividend payout over time.
– EPS allows for comparisons of the performance of different companies, aiding in the selection of the most suitable investment option.
– EPS, along with other financial methods, helps determine a company’s current and projected stock value. It also helps analyze if the stock price reflects the company’s market performance. The Price-Earnings Ratio (P/E) is often used by investors, where “E” represents earnings calculated using the EPS formula.
– EPS not only measures a company’s current financial standing but also tracks its past performance. A company with a consistently increasing EPS is generally considered a reliable investment option. Conversely, companies with fluctuating or irregular EPS are typically less favored by experienced investors.
Limitations of EPS (Earnings Per Share)
While earnings per share (EPS) is a powerful financial tool, it is important to consider its limitations. Here are a few drawbacks that investors and business owners should keep in mind:
– Business owners may manipulate EPS to present their venture as more profitable, but such attempts are often short-term strategies that can harm the long-term profitability and reputation of the business.
– EPS does not account for inflation, which can lead to misleading growth indications. Inflation affects the overall prices of goods and services, and if a company fails to purchase or sell more goods than in the previous year, it can result in an inaccurate EPS value.
– Cash flow, which is crucial for assessing a company’s ability to repay debt, is not factored into EPS calculations. Therefore, a high EPS may not necessarily reflect a company’s solvency.
Hence, when evaluating a company as an investment option, it is important to consider other important factors as well. Investors should assess EPS alongside other financial parameters to gain a comprehensive understanding of a business venture’s overall potential, profitability, and market performance.
