Earnings per share of the company is that portion of profits that are given to shareholders as their dividends. These are also denoted as EPS. Earnings per share shows the net earnings and position of the company. With a good earning per share, the company can attract several good investments. It is said that the higher the earning per share, the higher the profitability of the company.
In simple words, earning per share refers to the amount which is earned by a shareholder from each of his/her shares. The amount for earning per share is calculated by dividing the number of shares from the amount which is left from net profits after providing for all the other expenses. So, if there were higher profits, then the earnings per share would also be high.
Earnings per share is the matrix that is often used by investors for calculating the value of the company or stocks.
A company is required to disclose their earnings per share in their consolidated statement of operations, including both the statement’s quarterly and annual SEC filing.
When a company earns high profits, then it can decide whether they want to give them a dividend which leads to an increase in earnings per share of the company, or they can reinvent them also but a part of them.
Earnings per share is a very useful metric that is used in many ways. One of its uses is the calculation of the price to earnings valuation ratio. Investors can use them in calculating the value of the stocks of the company and also determine how much the market is willing to pay for each dollar. These are not directly used by all the shareholders. Investors compare the price and earnings before investing.
According to the financial accounting standards board (FASB), information related to earning per share is used in the income statement’s four major categories. These are continuing operations, discontinuing operations, net income, and extraordinary items.
Earnings per share are considered as of two forms, basic earnings per share and diluted earnings per share. Basic earnings per share is used in most cases. It is calculated by considering the company’s net income, which is divided by the number of shares of the company.
But diluted earnings per share is somehow equal to or less than basic earnings per share because it includes some more expenses.
In this article, we are going to see detailed information about earnings per share. We from Odint Consulting are here to provide you with knowledge about the concept. Furthermore, we will discuss the detailed definition, formula and calculations, forms, and more about earning per share. Let us start with the definition.
What is earning per share?
EPS is said to be amongst the most essential financial measures. This indicates the profitability of the company. It is calculated by dividing the net income of the company by the number of shares. This tool is majorly used by market investors for calculating the profitability status of the company before buying the shares.
Some methods make that portion of the net income of the company which is distributed to shareholders of that company for their stock holding of the company. Investors used this tool for calculating the value of stocks.
A company is required to disclose its earnings per share in the annual and quarterly statements of operations of the company.
Calculations of earning per share
Earnings per share is the net income that is distributed after providing preference dividends. In the case of cumulative preference share, annual dividends will be deducted whether declared by them or not. It is not relevant to have dividends in arrears while calculating earnings per share.
Formulas for calculating earnings per share
Earnings per share can be calculated by three methods. These are as follows-
- Basic formula
Earnings per share = profits-preference dividend /weighted average common shares.
- Net income formula
Earnings per share = net income-preference dividend / average common shares.
- Continuing operations formula
Earnings per share = continuing operations income – preferred dividend / weighted average common shares.
Balance sheets and income statements are used for calculating the average common shares and the dividend paid on the stock of preference shares. As the number of shares keeps on changing, so for more accurate results, weighted average common shares are used.
Uses of Earning per share
Earnings per share is an important financial measure that is used for calculating the profitability status of the company. This is one of the major components which is used in calculating the price to earnings valuation ratio. Investors can easily find the value of stock simply by dividing share price by earnings per share.
Earnings per share is one of the major components used as an indicator for stock picks. For investing in stocks, you can hire a suitable broker who will help you.
Comparison of earnings per share in absolute terms does not mean for investors. The reason is that ordinary shareholders do not have direct access to their earnings. But they can compare market price and earnings per share for calculating the value of their stocks in the market.
Limitations of earning per share
By using net income, we can calculate the value of the stock, and that is one of the limitations of earning per share. Non-cash expenses are to be subtracted from net income. These expenses include depreciation, amortization, etc. Capital expenses are not included in this. Different businesses have different non-cash items, which will affect net incomes. The net income of the company does not disclose its cash flow and health of that company.
Further, companies do manipulate earnings per share by changing the number of shares so that they can make favorable reports for attracting more investors to the company.
Earnings per share is used as an important component in calculating other metrics. The two most common ratios which it used are price to earnings valuation ratio and return on equity ratio.
Diluted earnings per share
Diluted earnings per share is the financial measure that is calculated by using fully diluted outstanding shares. This also includes the impact of the stock option grants and convertible bonds. This indicates the worst scenario, which is like the issuance of stock to all the outstanding stocks, warrants, and convertible bonds that would result in reducing the earning per share.
Calculations for diluted earnings per share
Diluted earnings per share calculations have variations. It is calculated by dividing net incomes minus preference dividend and divided by the weighted average of common stock, which is outstanding for the past year, and adjusted for diluted shares. Some organizations use numbers of outstanding shares at the end of reporting period for making this simpler.
Some methods make the calculations of earnings per share simple and eliminate inappropriate assumptions. These include replacement of primary earnings per share with basic earnings, use of diluted earnings per share method instead of treasury stock method of accounting, elimination of three percent test of dual presentations, and providing information on individual dilute securities.
Diluted earnings per share vs basic earnings per share
Formulas and calculations of diluted earnings per share and basic earnings per share are stated above. The basic earnings per share is not shown as a factor for diluted shares that are issued by that company. The capital structure of the company includes stock options, Warrants, restricted stock units; if invested, then this will increase the total number of outstanding shares in the market.
For a better description of the effects of the additional securities on per-share earnings, some companies also use diluted earnings per share ratio. In which they assume that all the outstanding shares are issued.
While calculating fully diluted earnings per share, sometimes it is required to do some adjustments in the numerator.
Whereas basic earnings per share is calculated by dividing the net incomes of the company by its outstanding shares. This is commonly mentioned in the financial reports of the company. It has a simple definition, whereas diluted earnings per share have a more complex definition. Diluted earnings per share include not only current outstanding shares but also convertible securities and other stock options as well.
Earnings per share exclude extraordinary items
Earnings per share can be misled, whether intentionally or unintentionally, by using many factors. Analysts use different variations of basic earnings per share to avoid misleads. It is one of the common ways to avoid inflation.
For example, if a company sells its land, then the income received from this activity will be an extraordinary item. Because of its non-repeating nature, it is treated as an extraordinary item. If this is included while calculating earnings per share, then it will mislead the shareholders with its results. On the other hand, in case of unusual loss, it will also mislead the results of earnings per share.
Earnings per share from continuing operations
Suppose a company started with 500 stores and also had ₹5 as earning per share. And assuming that the company has closed 100 stores due to some reasons. And it is continued with 400 stores.
In the above illustration, earnings per share of 400 stores will increase because that closed 100 stores, perhaps operating losses. With the help of evaluation of earning per share from continuing operations, analysts can compare the prior performance with current performance.
Capital and earning per share relation
Capital is the important aspect of earning per share, which helps in generating income, but it is ignored most of the time. It is possible to generate the same earnings per share, but one company can generate the same with fewer assets. That company would be more effective in using its capital for generating this income. There is one metric which is used in identifying the effectiveness of the company is the return of equity. In the calculations of this matrix, earning per share is used.
Dividends and earnings per share
Earnings per share is used to track the company’s performance and profitability. Shareholders do not have direct access to the net profits of the company. A portion of net income is used for the declaration of dividends to shareholders. But some or whole of the earnings per share is retained by the company. Shareholders or their representatives are required to reduce that portion of earning per share through meetings.
It is not easy to define the connection between earnings per share and share price by the shareholders because they do not have direct access to the net income of the company. Particularly for those companies that did not distribute any dividend. There is an indirect relationship between the actual nominal value of earning per share and share price.
Price to earnings ratio and earning per share
It is helpful to make a comparison between two industries by using the price-to-earnings ratio. Although it seems like a stock whose cost is more relatively equal to earning per share, then it tends to be overvalued and vice versa. The investor wants to invest more in the which is expected to grow in the future. In the bull market, it is normal for the stocks which have a higher price-to-earnings ratio to have the same index as the other stocks
Good earning per share
Which value of earning per share will be considered good for companies depends on the factors such as expectations of the analyst regarding the stock, performance of the company, performance of the competitors. Sometimes, even if the analysts expected higher value, then also the stock declined in respect of price and earning per share might be growing.
Further, a shrinking in earnings per share can lead to an increase in the price if the analysts expect an even worse result. It is always important to judge the results of earnings per share with the share price of that company, such as by looking at the company’s earnings yield or price to earnings ratio.
But a good earning per-share value varies from time to time. Higher the earning per share value with a good acceleration rate in its growth, more it is beneficial for the company. The company can increase its earnings per share by making buyback of shares, but if a company increases its number of outstanding shares faster than its earnings, then earnings per share will drop.
Difference between adjusted earnings per share and earnings per share
Adjusted earnings per share are also like earning per share where analysts make changes to the numerator. These changes consist of adding or subtracting some components from the net income of the company, which is deemed to be non-recurring.
For example, if a company has sold a building, then the sale proceeds from this will be reduced from the net income of the company because it is non-recurring. It will lead to a decrease in net income as a result. In this case, the net adjusted income and earnings per share will be lower than the basic earnings per share and net income.
Calculating earnings per share by using excel
For calculating earnings per share by using excel, firstly, we need to collect all the data and then put the net income, preference dividend, and a number of common shares outstanding into the adjusted 3 cells, namely From B3 to B5. After that, in cell B6, put the formula B3 – B4 for subtracting preference dividend from the net income. Lastly, in cell B7, put the formula B6/B5 for getting the results that are earning per share.
EPS can be a negative value. It means that the income of the company is negative, and it is losing money, or its expenses are more than profits. It doesn’t mean that any stock of the company is a sell.
EPS tells how much money a company’s shares have earned to its company. EPS is always calculated by taking away net income from preferred dividends and dividing it by the total number of outstanding common shares.
A higher amount of Earnings Per Share indicates a higher value for the reason that any investor would pay a higher amount for the shares. It will only happen if the investors think there has to be profit made when the company is doing good in the market concerning its share price.
Both the EPS and ROE are profitability ratios. EPS calculates the net earnings from each share from the common stock. ROE calculates the return that the shareholders have been receiving in return for their investments. Companies do provide their ratios in their annual or quarterly reports.
The EPS from shares of at least a growth of 25% when compared to the previous year indicates that the company has a stronghold in the market, even better when the growth has been consistent recently.
The EPS has to be present on the front of the company’s income statement if the stocks are public. It is the after-tax earnings that are divided by the so-called weighted-average no. of outstanding common shares.
The dividend is the way for companies to share their generated wealth. Generally, a cash payment, mostly drawn from profits, is paid to the company’s investors, i.e., the shareholders. These earnings are paid more commonly on a quarterly basis or annually.
EPS and Dividends are both a part of a company’s profitability. Earnings per share tell how profitable a company is based on its stocks. While on the other hand, dividends calculate the portion sent out to the shareholders.