Earnings Per Share (EPS): Meaning, Type and Importance

What is Earnings Per Share?

Earnings Per Share (EPS) is a pivotal metric reflecting a company’s value. It represents the earnings attributed to each outstanding equity share. Essentially, it measures a business’s profitability by showcasing the earnings generated per equity share.

How Are Earnings Per Share Calculated? (Formula and Example)

The formula for EPS essentially involves dividing the company’s net profit by its total outstanding equity shares. However, EPS computation involves various approaches, primarily:

1. Earnings per share: Net Income after Tax / Total Number of Outstanding Shares.
2. Weighted earnings per share: (Net Income after Tax – Total Dividends) / Total Number of Outstanding Shares.

For instance, let’s consider company JLQ Ltd with a net income of Rs 16 lakh, dividends of Rs 4 lakh, and a weighted average of 8 lakh shares. The EPS calculation would be –

= Rs (16 lakh – 4 lakh)/8 lakh

= Rs 2 per share

Therefore, the EPS of JLQ Ltd. would yield Rs 2 per share.

What are the Types of EPS?

1. Reported EPS: This follows Indian Accounting Standards (IndAS) and is disclosed in Stock Exchange filings. However, it can sometimes distort a company’s actual earnings due to one-time payments or unusual expense categorisations.
2. On-going EPS or Pro Forma EPS: Derived from ordinary net income, this type excludes irregular one-time income, aiding in anticipating core business earnings, but may not reflect actual profitability accurately.
3. Retained EPS: Indicates the earnings retained by the company instead of paying them as dividends. It’s often utilised for debt repayment, expansion, or future reserves, calculated by adjusting net earnings, current retained earnings, and dividend payouts against outstanding shares.
4. Cash EPS: Reflects a company’s true cash earnings and is harder to manipulate. It’s computed as Operating Cash Flow divided by Diluted Shares Outstanding.
5. Book Value EPS: Represents the average equity per share, offering insights into a company’s worth if liquidated and focusing on the balance sheet’s static representation.

Importance of Earnings Per Share

EPS holds substantial importance in evaluating a company’s financial health:

1. Comparing Performance: Helps investors compare companies for investment decisions, identifying promising options.
2. Long-term Analysis: Allows assessment of a company’s stability and growth potential over time. Consistent EPS growth indicates reliability, while irregularities might deter seasoned investors.
3. Profitability Indicator: Higher EPS often indicates increased profitability, potentially leading to higher dividend payouts.
4. Historical Tracking: Assists in tracking a company’s past performances, aiding in understanding its financial trajectory.

EPS serves as a crucial tool for investors, enabling comparisons among companies to make informed investment choices.

What is the use of Earnings Per Share?

Earnings Per Share (EPS) helps in comparing the various companies’ performance and helps investors choose the most appropriate investment choice.

Limitations of EPS

Despite its utility, EPS has limitations that warrant caution:

1. Manipulation: Businesses may manipulate EPS to showcase short-term profitability, impacting long-term credibility.
2. Ignoring Cash Flow: High EPS doesn’t guarantee robust financial health, as it overlooks crucial factors like cash flow, affecting solvency assessment.

Conclusion

EPS serves as a fundamental metric in evaluating a company’s profitability and aiding investment decisions. However, understanding its limitations is crucial for a holistic assessment of a company’s financial standing.