Earnings per share = Net Profit After Interest, Tax and Preference Dividends / Number of Shares
Earnings Per Share or EPS is a measure of the financial performance of an organization. The ratio of EPS informs shareholders of the amount of profit attributable to each share of the company. EPS is the amount of profit earned per share of the company. The result of the ratio is in absolute amount, and a higher amount represents better performance.
Let’s say that if a company’s net profit after interest and tax is $50,000 and there are a total of 5,000 issued shares of the company. In this case, the earning per share of the company will be $5 per share.
In the EPS calculation formula, take the number of shares in the denominator as the weighted average number of ordinary shares outstanding at the date for which you are calculating EPS.
It is essential to understand that EPS is a very indicator of a company’s financial performance. It is even a better indicator than profit for the year.
Let’s take the example in the below table containing some fictitious companies’ data. We can note that Zakoota LLC has earned a profit of $900,000, much higher than the profit of the other two companies, but it has a lower EPS of $36 than the other two companies.
The earning per share (EPS) is simple to understand ratio and an ordinary investor or shareholder can interpret it easily. The higher the per-share earnings is, the better the company’s performance is. If the answer of the ratio goes into a negative figure, then it means there has occurred a loss per share equivalent to the amount of the ratio.
Earning per share is also referred to as basic earnings per share or simple earning per share. All that we have read above is about basic earnings per share or simple earning per share. One variation of the EPS is to calculate primary Earning Per Share (PEPS). Primary earning per share excludes preference dividends from the formula of EPS.
Diluted Earnings Per Share
Let’s assume that if a company issues additional shares, then the existing income will be divided among more number of shares. This increase in the number of shares will decrease (dilute) earnings per share.
Diluted earning per share takes into account of all convertible share options. If all convertible share options get converted into ordinary shares, then the total number of shares will increase and earning per share will decrease.
So, to understand, what will happen if lenders exercise all the conversion options, we can calculate diluted earnings per share.
Convertible options mostly comprise of staff share options, directors share options, convertible preference shares, convertible bonds etc.
The formula for calculation of diluted earning per share is below:
Diluted EPS = Profit after interest, tax and preference dividend / (Weighted average shares outstanding + Convertible shares)
To calculate weighted average shares for basic or diluted EPS, let’s take an example. If a company, Zakoota LLC, had outstanding shares at the beginning of the year (1 January) of 10,000 until mid of the year, i.e., 30 June. Then, the company issued additional 15,000 shares and at the end of the year (31 December) there were a total of 25,000 shares outstanding. Now, how to calculate weighted average shares for EPS calculation?
Weighted Average shares = (10,000 * 6 / 12) + (25000 * 6 / 12) = 17,500
EPS is widely used in financial analysis and for investment decision purposes. It is easy to understand, easy to calculate and easy to comprehend. We can also compare EPS across different companies as well as various industries. It is especially relevant for the prospective shareholders as it is directly related to the earning of the shareholders. However, it is essential to understand that directors may not distribute all earnings of the company among shareholders immediately. Therefore, an investor should not expect to receive calculated EPS as a dividend. It depends upon the directors of the company how much dividend they want to distribute among shareholders.