Earnings per Share (EPS)
Earnings per share (EPS) is the portion of the company’s distributable profit which is allocated to each outstanding equity share (common share). Earnings per share is a very good indicator of the profitability of any organization, and it is one of the most widely used measures of profitability.
The earning per share is a useful measure of profitability, and when compared with EPS of other similar companies, it gives a view of the comparative earning power of the companies. EPS when calculated over a number of years indicates whether the earning power of the company has improved or deteriorated. Investors usually look for companies with steadily increasing earnings per share.
Growth in EPS is an important measure of management performance because it shows how much money the company is making for it’s shareholders, not only due to changes in profit, but also after all the effects of issuance of new shares (this is especially important when the growth comes as a result of acquisition).
The EPS is calculated by dividing net profit after taxes and preference dividends by the number of outstanding equity shares. This can be expressed in terms of the following formula:
Earnings per share = (Net Profit after Taxes – Preference Dividends) / Number of Equity Shares
If the capital structure changes (i.e. the number of shares changes) during the reporting period, a weighted average number of equity shares is used to for the calculations of EPS.
The diluted earning per share (Diluted EPS) expands on basic EPS and includes the shares of all convertible securities if they were exercised. Convertible securities are convertible preferred shares, stock options (usually employee based), convertible debentures and warrants.
Norms and Limits
It should be noted that two different companies could generate the same EPS but one could do so with a lesser equity. All other things being equal, this company is better than the other one because it is more efficient at using its capital for generating profits.
It is important that the investors do not rely on only measure of earnings per share for making investment decisions. Instead they should use in conjunction with other measures and financial statement analysis.