Earnings Per Share (EPS) - Meaning, Types & Importance

The earnings per share or EPS is a significant metric in the realm of stock investment. Earnings per share calculates the measure of a company’s profitability by giving values of the amount of profit each share of a company’s common stock earns. The EPS is computed when you divide the net income of a company (without dividends) by the total amount of shares outstanding. In case a calculation shows an EPS on the higher side, it indicates that the company is making positive gains. Such companies may be highly attractive to investors as they portray the potential for earning and let investors know that the company is doing potentially well in terms of its operations and overall performance.  

In simple terms, the earnings per share reflects the profit made by any given company based on the value of each share of its stock. In a sense, it shows the value of any company and the value of its stock so that investors may know whether to invest in it. The EPS indicator is vital for investors and knowing its meaning, types, and importance is relevant in any investor’s journey.  

What is earnings per share (EPS)? 

By now you must have gauged what the earnings per share value indicates. Going into some details about it may help you grasp the concept of this indicator better. Here are some key takeaways that will help you to understand EPS:  

• EPS or earnings per share is a criterion that portrays the amount of profit earned by each share of any given company.  

• It can be calculated by a simple mathematical formula. 

• You can use the physical formula to calculate the metric or use an online calculator. 

• If the EPS ratio is found to be on the high side, it translates to the company being perceived as a valuable investment by investors. Consequently, the stock of the company will be highly valued too.  

Earnings Per Share (EPS) Formula 

Investors must know how to define earnings per share as it can potentially help them to make informed investment decisions, particularly when it comes to equity investment. Additionally, knowing the mathematical formula and its components for calculating this measure is vital. Here is the formula to compute the measuring standard of earnings per share:  

EPS = (Net Income - Preferred Dividends)/Average Shares Outstanding 

The formula can best be understood with an illustrated example, mentioned below:  

Assume that the company “ABC” shows a net income of ₹50,00,000. The company “ABC” must pay its shareholders preferred dividends at the value of ₹5,00,000 in total. Additionally, the company possesses ₹5,00,000 worth of outstanding shares in common. If you replace these values to fit in the formula shown above, you get:  

EPS = (₹5000000 - ₹500000)/₹500000 = ₹9  

Therefore, the company “XYZ” has an EPS of ₹9 for any given period in which it was calculated.  

To calculate any company’s earnings per share according to the values in the formula, investors must look at a given company’s balance sheet and income statement. Nonetheless, you may get the EPS of any company for a given period from their quarterly or annual reports. Additionally, while computing the EPS, you may consider a common share weighted average to be used. The reason for this is that, over time, the exact quantity of shares is likely to differ.  

Something important to note while calculating the EPS is that the dividends on the non-cumulative and cumulative preferred shares of a company impact the EPS in different ways. Therefore, EPS may differ according to the kinds of dividends employed while making the EPS calculation. 

Types of Earnings Per Share (EPS) 

Earnings per share reflect several calculations, and every one of these represents a different aspect of this financial standard. The particular EPS that is used can affect the valuation of a company’s stock, potentially implying overvaluation or undervaluation (in its EPS ratio, for instance). Here are the different kinds of EPS you should know about:  

• GAAP EPS/Reported EPS: GAAP EPS or reported EPS is the calculation of EPS by using the guidelines and systems established by GAAP or generally accepted accounting principles. GAAP represents a standardised collection of accounting regulations and processes that are employed by companies to make their financial statements ready. Reported EPS or GAAP offers you a consistent and transparent measure of the financial performance of any company as it is based on specifically authorised principles of accounting. The formula for computing earnings per share through GAAP is:  

Reported EPS = (Net Income - Preferred Dividends)/Weighted Average of Outstanding Common Shares 

• Pro Forma EPS/Ongoing EPS: This is a measure that has been modified for computing the EPS. The computation excludes non-recurring or one-time occurring items while gauging a company’s financial statements. The EPS calculated through this method offers a precise picture of any company’s sustainable earnings or those that are of a recurring nature. Therefore, a company’s core profitability can be known. The calculation is done thus:  

Ongoing/Pro Forma EPS = (Net Income - Preferred Dividends - Non-recurring Gains)/Weighted Average of Outstanding Common Shares  

• Cash EPS: An EPS ratio achieved through this system is a variation of the EPS formula and measures a company’s generation of cash from the operations of the company. It is calculated with the formula below:  

Cash EPS = Cash Flow through Operations/Diluted Outstanding Shares  

• Retained EPS: In this calculation of earnings per share, a company’s retained earnings are considered. These are the earnings that comprise the net income of the company that is not paid out as dividend payment but remains with the company for its reinvestment back into the company’s business. The retained EPS formula is below: 

Retained EPS = (Net Earnings + Current Retained Earnings) - Dividend Paid/Weighted Average of Outstanding Common Shares  

• Book Value EPS: The book value EPS is the standardised measure that computes the earnings per share according to any company’s book value. Essentially, the book value represents the difference between the total assets of a company and the total liabilities of a company. This reflects any business’ net asset value, and is calculated in the following manner: 

Book Value EPS = (Total Equity - Preferred Equity)/Weighted Average of Outstanding Common Shares 

Importance of Earnings Per Share (EPS) 

The value of earnings per share is important for the following reasons:  

• Evaluation of Company Profitability: The EPS offers insights into a company’s potential to deliver profits. 

• Tool for Comparison: The EPS value permits a convenient way to compare the performance of any given company with its competitors, both domestically, and globally.  

• Valuation of Share Price: Investors typically employ the EPS measure for determining a company stock’s fair market value.  

• Decision-Making In Investment: Investors who calculate the EPS are informed about a company’s ability to generate long-term profits. Hence, they can decide to invest in a company, based on this value, along with other metrics.   

Limitations of Earnings Per Share (EPS) 

To accurately understand and define earnings per share as a concept, you need to know all about it, including its limitations. These are highlighted below:  

• Typically, some companies may manipulate the values of EPS to reflect high profits.  

• Any EPS profit values attained in the short term may not be an accurate measure of a company’s long-term ability to make profits.  

• The calculation of EPS does not account for shifts in net income due to the impact of inflation.  

• Within the investor community, the solvency of any company is a crucial reliability metric that potentially results in the trust of investors investing. When investors trust a company due to its various performance and fundamental metrics, they will invest in its stock. Trust translates to the stability of the company in the long term. The solvency aspect is not considered in the EPS calculation.  

Conclusion 

A crucial metric, EPS, or Earnings Per Share, aids investors and financial analysts in assessing a company’s level of profitability reflected per share. The calculation of EPS can be easily executed by the application of a simple formula. There are different types of EPS calculations depending on the profitability ratio investors wish to assess. However, although EPS serves as a proficient tool in the measurement of the profitability of a company and helps to make educated investment decisions, it is not without its limitations. For instance, the EPS tends to ignore the effects of inflation and potential manipulation. Consequently, while using EPS to learn about a firm’s profitability, other metrics to evaluate a company’s creditworthiness are necessary to get a complete grasp of the company’s standing.