Earnings Per Share
Earnings per share (EPS), also known as net income per share, is a market prospect ratio that calculates the amount of net income made per outstanding share of stock. In other words, this is the amount of money that each share of stock would get if all profits were divided at the end of the year to all existing shares.
Earnings per share is another measure that indicates how lucrative a corporation is on a per-share basis. Profits per share of a larger firm may therefore be compared to profits per share of a smaller company.
Obviously, the number of outstanding shares has a significant impact on this computation. As a result, a larger firm must distribute its profits over many more shares of stock than a smaller one.
Earnings Per Share Formula
Earnings per share, also known as basic earnings per share, is derived by deducting preferred dividends from net income and dividing by the weighted average number of common shares outstanding. This is the earnings per share formula.
Earnings Per Share = Net income – Preferred Dividends / Weighted Average Common shares Outstanding
Importance of Earnings Per Share
When it comes to assessing a company’s financial health and profitability, the following points highlight the importance of Earnings Per Share.
1. It assists in comparing the performance of prospective firms in order to select the best investment choice.
2. EPS may also be used to compare a company’s financial status over time. Companies with consistent EPS growth might be a safe bet for investors. In contrast, erratic earnings per share (EPS) are often disliked by seasoned investors.
3. A higher EPS indicates more profitability, which suggests that the dividend distribution may be increased over time.
4. Earnings per share (EPS) not only helps gauge a company’s present financial position, but it also helps trace its previous success.
Earnings Per Share Example
ABC Co. is a small business with no preferred shareholders, 10,000 outstanding ordinary shares, and a yearly net income of $100,000.
EPS = $100,000 / 10,000
EPS = $10
Earnings per share are equivalent to any profitability or market potential ratio. A higher ratio is usually preferable to a lower ratio since it indicates that the firm is more lucrative and has more money to give to its shareholders.
Although many investors ignore the EPS, greater earnings per share ratio generally cause a company’s stock price to grow. Because so many factors may impact this ratio, investors tend to look at it but don’t allow it to influence their judgments.
What is a Good EPS?
What constitutes a good EPS is defined less by its absolute value and more by its year-over-year change. The absolute value of a company’s EPS should rise each year, but the rate of rise should also quicken.
The EPS of a corporation might fluctuate due to changes in earnings, the total number of shares outstanding, or both. A company’s EPS can be increased by growing its earnings or decreasing its share count through share buybacks, but if it raises its outstanding share count faster than its earnings, its EPS will fall.
Stock investors can further examine a company’s earnings per share (EPS) by comparing it to its P/E ratio and evaluating how the company’s share price fluctuates in relation to its earnings.
Basic EPS Vs. Diluted EPS
Basic earnings per share (EPS) is a straightforward measure of profitability. Diluted EPS, on the other hand, is a more complicated metric.
Basic EPS is the most appropriate, although not particularly good, a method for determining a company’s financial health. Diluted EPS is a far better and more stringent method of determining a company’s financial health.
Basic EPS may be determined simply by subtracting the preferred dividend from net income and dividing it by the number of outstanding equity shares.
Diluted EPS, on the other hand, maybe computed by adding net income, convertible preferred dividend, and debt interest and then dividing the total by the company’s outstanding shares plus all convertible instruments.
For enterprises with a simple capital structure, basic EPS is employed. Diluted EPS is employed by firms with complicated capital arrangements.
Because all convertible instruments are added to the common shares in the denominator in diluted EPS, basic EPS is always greater than diluted EPS.
Limitation of EPS
The biggest limitation of using EPS to appraise a stock or company is that it is computed using net income. Non-cash expenses such as depreciation and amortization are deducted from net income, and the lumpy nature of capital expenditures can cause a company’s net income to vary significantly across reporting periods.
Non-operating expenditures, such as tax and interest payments, can have a significant impact on net income. Net income does not fully represent a company’s cash flow or the health of its business.
Furthermore, firms may and do alter their earnings per share (EPS) figures by manipulating the number of shares outstanding. Share issuances split, and stock buybacks all affect the denominator used to divide net income less preferred dividends.
EPS figures are most relevant when compared to other measures. The price/earnings (P/E) ratio, which compares a firm’s stock price to its earnings per share (EPS), and the return on equity (ROE), which measures how much profit a business earns from its net assets, are the two most prevalent.
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