What is Equity Share Capital? Learn its Meaning, Types, Risks, Features & Formula
When investing in shares, profitability is an important factor to consider. It is the goal of every investor to make a profit from their investments in a company’s stock. Without profit, investment doesn’t make sense, does it? Therefore, a useful measure to understand the profitability of a company is to calculate its earnings per share or EPS.Consequently, investors and companies have been touting it as the holy grail of financial performance for a very long time. Investors use this metric to compare companies and determine which ones can be more profitable. They also determine which ones potentially offer a higher return on investment. Therefore, in this blog, we will delve into the concept of EPS in stock market, EPS full form in finance, EPS types, and how to calculate earning per share.
What is Earnings Per Share (EPS)?
EPS meaning in share market is a financial metric that is widely used to assess a company’s profitability and performance. The EPS full form in stock market is Earnings Per Share. It is an essential component of the financial statements that investors and analysts use to evaluate a company’s worth and make investment decisions. A company earns a measure of profit for each share of common stock outstanding.
In the share market, people commonly use it to evaluate a company’s worth and make investment decisions. Thus, investors and analysts use this metric to compare companies within the same industry or sector. They use EPS to determine which ones can be more profitable. It is also useful in identifying high EPS stocks that have the potential to provide higher returns.
One can use it in conjunction with other financial metrics. This includes Price to Earnings (P/E) ratio. This can be done to determine a company’s value and growth potential. Thus, you can use this metric to compare companies within the same industry. Also, you can identify potential investment opportunities. Additionally, it affects the market price of shares, so an increase in total corporate value follows.
What is EPS Ratio?
The price-to-earnings (P/E) ratio is also known as the EPS ratio or Earning Per Share ratio. It can calculate the relative value of a company’s shares based on its earnings per share.
To calculate the Price Earnings (P/E) ratio, divide the earnings per share of a company by its current market price. Therefore, this ratio allows for a comparison of a company’s valuation with its competitors, industry average, or historical data.
For example,
If a company has a current market price of ₹100 and an EPS of ₹10, the EPS ratio would be 10 (₹100 / ₹10). This means that investors might be willing to pay 10 times the company’s earnings per share for its shares.
A high EPS ratio can indicate that investors have overvalued a company. On the other hand, a low EPS ratio can indicate that investors have undervalued a company. However, it’s important to consider other factors. This includes a company’s debt, cash flow, and future growth potential before making investment decisions.
What is the Importance of EPS Ratio?
The company’s earnings per share (EPS) serves as a key profitability indicator. Its significance lies in the following aspects:
- It helps to compare the performance of various companies and choose a suitable investment option.
- It also helps to give insights into the company’s financial progress over time. A consistent rise in EPS may signify profitability, making the company a good investment.
- A higher EPS may indicate heightened profitability, increasing the potential for earning substantial dividends.
- Apart from reflecting current financial health, EPS also serves as a historical performance indicator for the company.
How are Earnings Per Share Calculated?
Companies use Earnings Per Share as a key financial metric to assess their profitability and financial health. They calculate it by dividing the earnings available to common shareholders by the Weighted Average Number of Shares Outstanding.
Investors and analysts use this metric to compare companies, identify high EPS stocks, and make informed investment decisions.
What is the Formula for Calculating Earnings per Share?
In a nutshell, the Earnings Per Share formula is:
Earnings Per Share = Net Income − Preferred Dividends / End-of-Period Common Shares Outstanding
Therefore, the balance sheet and income statement are used, along with dividends paid on preferred shares (if any) and net income to get a company’s financial progress. Therefore, it is important to note that no deduction from net income for dividends paid on common stocks.
Thus, the higher the EPS, the more likely it becomes suitable for investing.
Calculate Earnings Per Share Using Excel
To calculate Earnings Per Share in Excel, you will need to input the following information:
- Net Income
- Preferred Dividends (if any)
- Weighted Average Number of Shares Outstanding
Once you have inputted the necessary information, follow these steps:
- Subtract the preferred dividends from the Net Income to arrive at the earnings available to common shareholders.
- Calculate the weighted average number of shares outstanding. This can be done by multiplying the number of shares outstanding in each period by the number of days in the period. Thereafter, add up the total and divide by the number of days in the period.
- Divide the earnings available to common shareholders by the weighted average number of shares outstanding to arrive at the earnings per share.
Earnings Per Share Example
Let’s assume that Peter has decided to invest in either Ali’s Ice Cream or Ed’s Carpet and is confused about which one to choose. To help him make a decision, Peter decides to compare the earnings per share of both companies.
Ali’s Ice Cream
After doing some research, Peter finds out that Ali’s Ice Cream reported a net income of ₹10 crores for the fiscal year, and has 2 crore outstanding shares.
EPS for Ali’s Ice Cream = Net Income / Average number of outstanding shares
= 10 Crore / 2 crore shares
= ₹5 per share
Ed’s Carpet
Similarly, Peter finds out that Ed’s Carpet reported a net income of ₹8 crore for the fiscal year, and has 4 crore outstanding shares.
EPS for Ed’s Carpet = Net Income / Average number of outstanding shares
= ₹8 crore / 4 crore shares
= ₹2 per share
From this analysis, Ali’s Ice Cream Company is a clear winner as it has a higher EPS of ₹5 per share. However, Peter should conduct further research and analysis to make an informed decision about which company to invest in.
How is EPS Used?
Earnings per share ratio can serve as a critical metric for evaluating a company’s profitability from a compliance standpoint. Furthermore, it plays a significant role in determining the price-to-earnings (P/E) ratio, where the “E” represents EPS. The calculation potentially involves dividing a company’s share price by its earnings per share. This may offer insights into the stock’s value and how much the market is willing to pay for each dollar of earnings.
EPS stands among several indicators available for stock selection within the compliance framework. Individuals engaged in stock trading or investing are advised to proceed by selecting a stockbroker in while ensuring compliance with relevant regulations.
However, assessing EPS in isolation may not provide meaningful insights. Therefore, investors commonly compare EPS with the stock’s share price to gauge the value of earnings and understand investor sentiments regarding future growth.
Type of Earnings Per Share
There are two different types of earnings per share: Basic and Diluted EPS. Basic is a calculation that uses the net income of a company divided by the total number of outstanding shares. While diluted share is a calculation that takes into account all potentially dilutive securities that could be converted into diluted earnings per share.
(Note: Diluted EPS is usually lower than basic EPS because it considers the impact of potentially dilutive securities.)
List of two distinct types of earning per share: Diluted EPS vs Basic EPS.
| Parameter | Basic | Diluted |
|---|---|---|
| Definition | A calculation that uses the net income of a company divided by the total number of outstanding shares to determine the earnings per share. | A calculation that takes into account all potentially dilutive securities that could be converted into shares. Such as stock options, convertible bonds, and other securities that could be converted into shares in the future. |
| Formula | Basic EPS formula:Net Income / Total Outstanding Shares | Diluted EPS formula:Net Income / (Total Outstanding Shares + Potential Dilutive Securities) |
| Considerations | Only takes into account the number of outstanding shares | Takes into account potentially dilutive securities that could be converted into shares |
| Impact | Basic EPS is usually higher than diluted EPS | Diluted EPS is usually lower than basic EPS |
| Usefulness | Used to assess a company’s profitability and potential for growth | Used to provide a more accurate picture of a company’s earnings per share, as it takes into account potentially dilutive securities. |
| Importance | One of the most commonly used metrics in the share market | Used to determine the true earnings power of a company and its growth potential. |
EPS Calculation: Basic and Diluted
Let’s assume a company has a net income of ₹100,000 and 10,000 outstanding shares. The company also has 2,000 potentially dilutive securities in the form of stock options and convertible bonds.
Basic EPS Calculation:
Basic EPS formula = Net Income / Total Outstanding Shares
= ₹100,000 / 10,000 = ₹10 per share
Diluted EPS Calculation:
Diluted EPS formula = Net Income / (Total Outstanding Shares + Potential Dilutive Securities)
= ₹100,000 / (10,000 + 2,000) = ₹7.69 per share
In this example, ₹10 is the Basic EPS per share and ₹7.69 is the diluted earnings per share. This means that the Diluted EPS takes into account the impact of potentially dilutive securities, resulting in a lower EPS than the Basic EPS.
What is the Difference Between EPS and Adjusted EPS?
When companies disclose their EPS (earnings per share) figures, they often use their net income numbers after adjusting the one-time profits. Such as losses from specific occurrences or earnings generated from the sale of business units. The outcome is known as adjusted EPS.
Certain companies adjust their net incomes to enhance their earnings per share values. This can be achieved through alterations in accounting procedures for reported earnings or by engaging in substantial share buybacks. This may lead to an artificial inflation of their earnings per share values. Additionally, if non-recurring income components are not appropriately adjusted, it may result in an overstated earnings per share value.
Factors that Impact the Earnings Per Share
Earnings Per Share can be impacted by a variety of factors. Here are some of the key factors that can impact earnings per share:
- Changes in Net Income: Net income is the main driver of EPS. This means any changes in the company’s profitability will impact EPS. If a company’s net income increases, it will increase, and vice versa.
- Changes in the Number of Shares Outstanding: It is calculated by dividing net income by the number of outstanding shares. Therefore, any changes in the number of shares outstanding, such as through stock issuances or share buybacks, will impact earnings per share.
- Changes in Dividends: Dividends are payments made to shareholders out of a company’s profits. If a company increases its dividend payout, this will reduce the retained earnings that could be used to increase net income and, therefore, reduce earnings per share.
- Stock Buybacks: Stock buybacks occur when a company repurchases its shares from the market. This reduces the number of outstanding shares, which can increase earnings per share. However, it’s important to note that while EPS may increase, the company’s overall profitability is not affected by stock buybacks.
Interpretation of Earnings Per Share
Here are some key points to keep in mind when interpreting EPS:
- Higher EPS: A higher EPS indicates that a company is more profitable and generates more earnings per share. Factors such as changes in net income, changes in the number of shares outstanding, changes in dividends, and stock buybacks can impact earnings per share. Therefore, it’s important to consider these factors when interpreting earnings per share.
- Comparison to Industry Standards and Competitors: It can be useful to compare a company’s EPS in stock market to industry standards and competitors. It gives a sense of how well the company is performing relative to others in the same industry. However, it’s important to consider other factors before making investment decisions based solely on earnings per share comparisons.
- Potential Limitations: You should be aware of the potential limitations of earnings per share as a metric. Earnings per share can be manipulated by accounting practices and changes in the number of outstanding shares. Therefore, so it’s important to consider other financial metrics in addition to earnings per share when evaluating a company’s performance.
- Historical Trends: Analyzing a company’s earnings per share over time can provide insight into its growth and profitability trends. Consistent growth in EPS in share market can be a positive sign, while a decline in EPS in share market over time may be cause for concern.
Limitations of Earnings Per Share
Despite its widespread use, there are some limitations to using earnings per share as a financial metric in the stock market. In this section, we will discuss three main limitations.
- Can be Manipulated: Companies have the ability to manipulate their earnings to achieve a certain EPS level. This can be done through accounting adjustments, aggressive revenue recognition, or expense deferral. Therefore, investors and analysts should be cautious when relying solely on EPS.
- Doesn’t Consider Inflation: We calculate earnings per share based on current earnings, and we do not account for inflation. This means that earnings per share can be misleading over the long term since it doesn’t reflect the impact of inflation on a company’s financial performance.
- Does Not Reflect the Quality of Earnings: Earnings per share may not provide information about the quality of earnings. Such as whether the earnings are sustainable or whether they are generated from the company’s core operations.
EPS – Key Points To Remember
- Earnings per share (EPS) is a crucial measure, indicating the profit a company can generate for each of its stock shares.
- In cases where a company has a diverse capital structure that includes stock options or warrants, diluted EPS is used, replacing basic EPS.
- The formula for earnings per share involves dividing the company’s net income after tax by the total number of outstanding shares.
- A major drawback of earnings per share can present a false picture of a company’s profits.
- Earnings per share can be the most effective when it is compared to the metrics of companies in the same industry or competitor benchmarks over a specific timeframe.
To Wrap It Up…
Earnings per share or EPS in share market is a profitability measure that investors define as the value of earnings per outstanding share of common stock. Generally, it is advisable to look for companies with higher EPS stocks. However, one should consider other factors specific to the company.
Overall, you should consider Earnings Per Share as an important metric when evaluating a company’s profitability and potential for growth. You should also consider it in conjunction with other financial metrics of the company. Also, if you are new to the stock market investment journey, you can refer to this article by smallcase – A beginner’s guide to stock market.
As always, investors must do their own research and/or consult their financial advisor before investing.
FAQs
A good EPS, or earnings per share generally signifies profitability. A good EPS is determined by multiple factors. This may include a company’s recent performance, its competitors, and analysts’ expectations associated with the stock.
Yes, EPS should be considered when buying stocks as it can provide insights into a company’s profitability. A positive and growing EPS in stocks may suggest a potential for dividends and overall financial health.
Factors increasing EPS include higher net income, share buybacks, and a reduction in the number of outstanding shares. Improved operational efficiency and increased profitability contribute positively to earnings per share.
When earnings per share are low or on a decline, it indicates that a company is less inclined to share its profits with shareholders through dividends. As a result, such a company can be a risky investment.
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