Monday, July 18, 2016

What is Earnings Per Share (EPS)?

Companies exit to make ‘Profits’ and distribute them to their shareholders, by way of ‘Dividends’ and ‘Capital Appreciation’, created out of retained earnings. Corporations draw up and present accounts after the end of every financial year, after getting duly audited, in the annual general body meeting of shareholders.  The audited financial statements also disclose the ‘Earnings Per Share’ or EPS. Is not the profit and loss statement, which along with the schedules and notes following it, just suffice? What is the need to compute and report the EPS?

Before we go into what is EPS, its significance, how it is computed etcetera, we must be clear in our minds that the corporation and its owners, the shareholders are distinct, with their own needs and interests.  While the annual financial statements, comprising the statement of profit and loss, assets and liabilities and cash flows, help the owners assess the performance of the company, they are inadequate to answer the nagging question in the minds of members, “What does it mean to me, personally?”

The statement of profit and loss focuses on the company’s perspective; what the company earned, while EPS focuses on what the shareholder earned.  EPS is profits of the company reduced to the individual share.  An investor can deduce what she earned simply by multiplying the EPS with the number of shares she owns; conversely, you get EPS by dividing the profits after tax by the total number of equity shares of the company. Lets consider the following example:

ABC Corporation’s results stood as follows: profit before depreciation, interest and tax Rs.1,000,000; depreciation 10,000; interest 5250; corporate income tax 344,600; total number of equity shares 100,000 of Rs.10 each.  The EPS is computed as follows:

Indian Rs.
Profit before depreciation, interest and tax

Corporate Income Tax
Net Profit After Tax
Total number of equity shares
Earnings Per Share (EPS)

Suppose an individual investor own 1000 shares in ABC Corporation, the company earned for her, 1000 x Rs.6.40 = Rs.6,400.

Earnings Per Share or EPS is an important component in calculating the ‘Price to Earnings’ or PE ratio, which in turn is a key tool in value investing.