Investing in a company requires a detailed analysis of its financial health and its future growth prospects. One of the key parameters in this process is evaluating the EPS of the company and its interpretation for the average shareholders and potential investors. However, calculating the basic EPS is not enough. There are many types of EPS that have individual interpretations and significance for investors. Given here are the details of different types of EPS and their relevance.
What is EPS and how to calculate it?
EPS or earning per share is a financial measure used to assess a company’s profitability per share and make informed investment decisions. It is calculated by dividing a company’s net income by its outstanding shares. To determine EPS, investors need to consider the net income from the income statement and the number of outstanding shares from the balance sheet or the company’s annual report. The formula to calculate EPS is given below.
EPS = Net income / Number of outstanding shares
Consider the following example to understand the calculation of EPS.
Suppose a company has a net income of Rs. 100 crore and has 10 crore outstanding shares. The calculation of EPS, in this case, is shown below.
EPS = (Net Income) / (Outstanding Shares)
EPS = Rs. 100 crore / 10 crore
EPS = Rs. 10
This means that the company earned Rs. 10 in profits for each share of its stock.
- Basic EPS
Basic EPS is a basic calculation of EPS that takes into account the net income and divides it by the total number of outstanding shares. The outstanding shares represent the number of shares issued by the company and held by investors. Basic EPS only considers the common shares outstanding and excludes any preferred shares or other financial instruments. Basic EPS is commonly used as the default measure of a company’s earnings per share.
- Diluted EPS
Diluted EPS is another measure of a company’s earnings per share that takes into account the potential dilution of earnings per share from any outstanding securities that can be converted into common shares. Dilution happens when a company issues more shares or securities that can be converted into shares, such as stock options or convertible bonds, which may reduce the earnings per share.
Diluted EPS assumes that all convertible securities are converted into common shares, and the earnings are divided by the total number of shares outstanding after conversion. It helps investors to understand the worst-case scenario if all the convertible securities were exercised.
- Reported EPS
Reported EPS is the EPS that is calculated by using the net income and the outstanding number of shares as reported in the financial statements of the company. These figures are calculated as per the applicable accounting standards and accounting policies. However, it can nevertheless be manipulated to mislead the shareholders and potential investors.
For example, if a company sells a piece of machinery and records the income from the sale as operating income under GAAP, the EPS will appear to increase. This is because the sale of the machinery is not considered a regular part of the company’s business, so it is not factored into the calculation of the company’s ongoing earnings. Similarly, a company may choose to treat certain expenses as “unusual” or “non-recurring” expenses, even though they are actually regular and ongoing expenses for the company. By doing this, the company can artificially improve its reported earnings per share.
Therefore, it is important to carefully evaluate a company’s financial statements and consider other factors such as the company’s growth prospects and financial health before making investment decisions.
- Ongoing EPS
Ongoing EPS (Earnings Per Share) is a financial metric that provides investors with a measure of a company’s profitability that excludes one-time or non-recurring gains or losses. It is calculated by dividing a company’s net income from ongoing operations by its total number of outstanding shares.
For example, let’s say a company has a net income of Rs. 100 crore for the year, but Rs. 10 crores of that income came from a one-time gain such as the sale of a property. The ongoing EPS would be calculated by subtracting the one-time gain from the net income to arrive at the net income from ongoing operations (Rs. 100 crore – Rs. 10 crores = Rs. 90 crores) and dividing that by the total number of outstanding shares.
Ongoing EPS is important for investors because it provides a more accurate measure of a company’s ongoing profitability. By excluding one-time gains or losses, ongoing EPS gives investors a better sense of the company’s underlying business performance. This can help investors make more informed investment decisions, particularly when comparing companies within the same industry.
- Adjusted EPS
Adjusted EPS (Earnings Per Share) is also used to measure a company’s profitability by excluding certain expenses or gains that are considered non-recurring or unusual. In contrast to ongoing EPS, adjusted EPS goes one step further and excludes the impact of certain accounting adjustments or other items that are not indicative of a company’s ongoing profitability.
These adjustments can include changes in accounting methods, which can artificially inflate or deflate a company’s earnings, making it difficult for investors to accurately assess the company’s profitability. For example, a company might change its accounting method for recognizing revenue from one year to the next, resulting in a significant increase or decrease in reported earnings. Adjusted EPS would exclude the impact of such accounting changes to provide investors with a more accurate measure of the company’s underlying profitability.
Another common adjustment included in adjusted EPS is the amortization of intangible assets, such as patents or trademarks or adjustments for currency fluctuations. Adjusted EPS provides investors with a more accurate measure of a company’s profitability, which can help them make more informed investment decisions.
- Annualised EPS
Annualised EPS, also known as the trailing EPS measures a company’s earnings per share over the past 12 months. It is calculated by adding up the company’s net income for the four most recent quarters and dividing that number by the total number of outstanding shares of common stock.
For example, if a company’s net income for the past four quarters was Rs. 50 crore and it has 10 crore outstanding shares of common stock, the trailing EPS would be Rs. 5 (50/10).
Annualised EPS is important for investors because it provides a snapshot of a company’s recent earnings performance. By looking at the company’s performance over the past year, investors can get a better idea of its current profitability and potential for future growth.
- Retained EPS
Retained EPS (Earnings Per Share) measures the amount of a company’s earnings that is retained or reinvested back into the business, rather than paid out as dividends to shareholders. It is calculated by subtracting the total dividends paid out to shareholders from the company’s net income and then dividing that number by the total number of outstanding shares of common stock.
For example, if a company has a net income of Rs. 100 crore and pays out Rs. 20 crore in dividends to shareholders, the retained earnings would be Rs. 80 crore. If the company has 10 crore outstanding shares of common stock, the retained EPS would be Rs. 8 (80/10).
A company that retains a large portion of its earnings may have greater potential for future growth and higher stock prices, but may also carry more risk. On the other hand, a company that pays out more dividends may have less potential for growth but may be more attractive to investors seeking stable income.
- Book Value EPS
Book Value EPS (Earnings Per Share) measures the net worth of a company on a per-share basis. It is calculated by dividing the book value of the company’s equity by the total number of outstanding shares of common stock. The book value of a company’s equity is the difference between the total assets and the total liabilities of the company. In other words, it is the amount of money that would be left over if all the company’s assets were sold and all its debts were paid off.
For example, if a company has a book value of Rs. 100 crore and 10 crore outstanding shares of common stock, the book value EPS would be Rs. 10 (100/10).
Book Value EPS is important for investors because it gives an indication of the intrinsic value of a company. If the market price per share is less than the book value EPS, then the stock may be undervalued and could be a good investment opportunity. However, other factors should also be considered when making investment decisions.
- Cash EPS
Cash EPS measures the company’s ability to generate cash flow from its operations on a per-share basis. It is calculated by dividing the cash flow from operations by the total number of outstanding shares of common stock. Cash flow from operations is the cash a company generates from its regular business activities, such as sales of products or services, minus any cash spent on operating expenses, such as salaries, rent, and inventory. Cash EPS is important for investors because it shows how much cash a company is generating on a per-share basis, which can help to determine the company’s ability to reinvest in the business, pay dividends, or pay down debt.
For example, if a company generates Rs. 10 crores in cash flow from operations and has 5 crore outstanding shares of common stock, the Cash EPS would be Rs. 2 (10/5).
Calculating cash EPS is important as it measures the actual cash generated by a company’s operations rather than just its reported earnings. This is particularly important because companies can manipulate earnings figures through accounting adjustments or other non-cash items.
The information about the different types of EPS allows different stakeholders to understand the true picture of the earnings of the company. It can also be used as an important tool for comparing different companies across the same industry. However, it is equally important to consider its limitations and also look at other factors such as a company’s assets, liabilities, cash flow, and growth potential when making investment decisions.
Some of the key limitations of using EPS are that it does not consider the quality of earnings, and it can be easily manipulated to show better earnings as part of window dressing. Similarly, EPS cannot be a reliable measure to compare companies across different industries as well as it does not account for the future growth prospects of the company.
A few factors that have a direct or indirect impact on the EPS of the company include the net income of the company, its outstanding shares, any stock dilutions on account of convertible shares or other securities, share buybacks, taxes, any impending mergers and acquisitions, changes in accounting policies, etc.
The two parameters in the calculation of EPS are the net income and the number of outstanding shares of the company.
It is difficult to determine the ideal EPS for a company as it depends on various factors that can be unique based on the type of industry, the size of the company, and other factors that are specific to the business of the company.