Earnings per Share (EPS) can be a part of both fundamental and technical analysis, depending on the perspective of the shareholder. Having said that, EPS is probably one of the most important metrics when it comes to analysis, because it takes into account two fundamental factors, both of whose intertwined dynamic is essential to a company’s survival, i.e. profit and shareholders.
Any business’s primary function is value addition, in a comprehensive manner. One of the aspects of this value addition is economic value addition, which basically means how much growth a company has ascertained in a particular period of time.
Earnings Per Share (EPS), as the name suggests, is a metric for exactly that kind of value addition. Of course, here both growth and economic value addition are considered synonymous to profits that a company earns, which is not a far fetched assumption, as profits are literally the bottom line.
EPS evaluates the earnings of the company with relation to the quantum of its shareholders. Simply put, EPS means the earnings of the company divided by number of outstanding shareholders.
Here's the basic formula used to claculate EPS
Discussing further, let's have a look at the different kinds of EPS.
There are two particular types of EPS:
1. Basic EPS:
In this type of EPS, only shares that are considered are the outstanding equity shareholders. Usually, a weighted average of shareholders remains, and the net income is considered after deducting necessary interests and dividends. The idea is to find out income attributable to each equity share holder.
For all thoughts and purposes, this is the type of EPS that is most frequently used.
2. Diluted EPS:
In calculation of such EPS, along with common shareholders, all the securities that can be converted into common stock, which by extension can have a claim on profit are included. The idea is that this ‘dilutes’ the EPS because the denominator would be substantially larger, because the inclusion is comparatively larger in terms of who has a claim on profit.
Common examples include convertible debt, convertible preferred shares, warrants and stock options, all of which can be converted into shares. Also, while the formula remains similar, for calculation of diluted EPS, it is assumed that all such options are exercised in the beginning of the period and no interest/dividend is paid.
A company has earnings of Rs. 1 Cr, not accounting for dividend paid on 10% Preferred Stock worth Rs. 1 Cr. Total outstanding shares as on the date of calculation are 1,00,000.
EPS = (Earnings: 1,00,00,000 – 10% Dividend: 10,00,000) / Number of Shareholders 1,00,000
= 90,00,000 / 1,00,000
= Rs. 90
Analysing, this means that the company has earned enough that Rs. 90 is attributable to each shareholder. However, note that EPS is not the same as the dividend that the company pays, it is simply a metric of measure.
EPS is one of the most frequently used tools by traders and investors alike, because while being simple in its essence, it is a pretty useful tool that takes into account two factors that affect highly affect the price of any share.
Secondly, EPS forms the basis of Price-to-Earnings (P/E) Ratio, which examines the relationship between market price of a share and its economic value addition, i.e its earnings.