What is earnings per share?

Earnings Per Share (EPS) is an indicator of the profitability and performance of a company that allows stakeholders, analysts, and investors to make informed investment decisions. EPS can be used to compare the performance of different companies in the same industry sector. A higher value of EPS, meaning Earnings Per Share, is more desirable since it indicates that the company is generating higher profits relative to its outstanding shares.

• Table of contents

• What are the different types of EPS?
• How to calculate earnings per share?
• Factors that affect earnings per share
• Importance of earnings per share
• How is EPS used?
• Diluted EPS vs. Basic EPS
• Adjusted EPS v/s EPS
• Limitations of earnings per share

What are the different types of EPS?

• Basic EPS: This calculates the earnings per outstanding share of common stock without taking into consideration the impact of dilutive securities such as stock options.
• Diluted EPS: It considers the potential dilution of outstanding shares from convertible securities, stock options, or warrants.
• Trailing EPS: It provides a retrospective view of the company's profitability by showing its historical earnings over the past twelve months.
• Forwards EPS: It estimates the company's future EPS based on analyst forecasts, management guidance, and market trends.

Also Read: What are EPS and PE ratios: Differences and similarities

How to calculate earnings per share?

Now that you know what is EPS and the types of EPS, you may be wondering how to calculate it. Here’s the EPS formula:

Earnings Per Share = (Net Income – Preferred Dividends) / Average Outstanding Shares

Factors that affect earnings per share

Here are 4 factors that may influence EPS:

• Revenue growth: ‘What is Earnings Per Share?’ It is the measure of the profitability of a company on a per-share basis. Therefore, anything that increases the income and decreases the expenditure of a company is likely to positively affect EPS.
• Share buybacks and dividends: Earnings per Share, by definition, represents the profitability of a company which explains why share buybacks and dividend distribution affect the value of EPS.
• Macroeconomic factors: GDP growth, interest rate movements and inflation affect corporate earnings, further affecting the EPS of companies.
• Cost management: Better cost management equals potentially improved profit margins and, as a result, higher EPS.

Earnings per share meaning should not be taken in the literal sense since the calculated value is merely a fundamental metric to gauge a company’s profitability and performance. EPS, by definition, reflects a company’s ability to generate profits compared to its outstanding shares. It provides insights into the financial health and performance of a company. A higher EPS encourages more investments and shapes market sentiments.

Importance of earnings per share

Earnings per share (EPS) is a key financial indicator that measures a company's profitability on a per-share basis. In mutual funds, particularly equity-focused ones, EPS helps assess the financial stability of the companies in the portfolio. A higher EPS typically indicates greater profitability, which can potentially positively impact the company’s stock price and, in turn, the mutual fund’s net asset value (NAV).

• EPS helps investors compare the profitability of companies within the same sector.
• It shows how much profit a company earns for each outstanding share.

A clear understanding of EPS aids investors in evaluating the potential performance of equity-oriented mutual funds.

How is EPS used?

EPS is widely used in financial analysis to assess a company’s profitability and support investment decisions. Mutual fund managers may consider EPS when selecting stocks for their portfolios, while investors use it to gauge the financial position of the companies their funds invest in. Observing EPS trends over time can indicate a company’s growth prospects. Analysts use EPS to project future earnings and potential stock price changes.

Diluted EPS vs. basic EPS

Basic EPS determines a company’s earnings per share based on its outstanding common shares. Diluted EPS, however, adjusts for the potential dilution that may occur if all convertible securities—such as stock options, warrants, and convertible bonds—are exercised.

Basic EPS: Computed by dividing net income by the weighted average number of outstanding common shares.

Diluted EPS: Adjusts for potential dilution by factoring in convertible securities.

Diluted EPS is always equal to or lower than basic EPS.

For mutual fund investors, diluted EPS offers a more cautious estimate of a company’s earnings, reflecting the possible effect of future share dilution on the fund’s investments. When evaluating potential funds, particularly those with holdings in companies issuing convertible securities, diluted EPS should be taken into account.

Adjusted EPS v/s EPS

Earnings per share (EPS) is calculated by dividing net income by the number of outstanding shares. However, some companies report an adjusted EPS, which excludes non-recurring items or one-time gains and losses that may distort the true picture of a company’s ongoing profitability.

• EPS represents the raw, reported earnings per share.
• Adjusted EPS aims to present a clearer view of recurring earnings.
• Adjusted EPS can be subjective, as companies decide which items to exclude.

When evaluating mutual fund holdings, investors should check whether EPS figures are adjusted and understand the exclusions to assess the reliability of a company’s earnings.

Limitations of earnings per share

While EPS is widely used, it has certain drawbacks, which are as follows:

• EPS can be influenced by accounting methods.
• It does not reflect a company’s debt or capital structure.
• It can be affected by one-time events, making it volatile.
• It does not measure actual cash flow.
• EPS alone does not provide a complete picture of a company’s financial health.

For a more thorough evaluation, investors should use EPS alongside other financial metrics, such as cash flow, debt-to-equity ratios, and price-to-earnings (P/E) ratios, to assess a company’s financial strength and its impact on mutual fund holdings.

Also Read: Price-to-Earnings (P/E) Ratio: Definition, uses and formula

Conclusion

Earnings per share (EPS) is a useful measure of a company’s profitability and can provide insights into the potential performance of equity mutual funds. Understanding the differences between basic, diluted, and adjusted EPS—as well as its limitations—is key to making informed investment choices. EPS gives a snapshot of a company’s profitability. It is most effective when analyzed alongside other financial indicators. Awareness of possible EPS adjustments is crucial.

FAQs

What is EPS meaning?

EPS, or Earnings Per Share, represents how much profit a company makes for each outstanding common stock share. It is a key measure for investors to evaluate a company's profitability on a per-share basis, offering insights into its financial condition and potential for shareholder earnings.

How is diluted EPS calculated?

Diluted EPS accounts for the possible reduction in earnings per share if all convertible securities, such as stock options or convertible bonds, were exercised. It is calculated by dividing the company's net income, adjusted for potential dilution, by the weighted average number of outstanding shares, including potential additional shares.

How is non-diluted EPS calculated?

Basic EPS, also known as non-diluted EPS, is derived by dividing the net income available to common shareholders by the weighted average number of outstanding common shares. This measure does not factor in any potential dilution from convertible securities, reflecting only the company's existing share structure.

What are the components of an EPS equation?

The EPS formula primarily consists of two key elements: the net income available to common shareholders and the weighted average number of outstanding common shares. For diluted EPS, it also factors in potential shares from convertible securities such as stock options and convertible bonds.

What is the use of Earnings Per Share?

Earnings Per Share (EPS) helps evaluate a company's profitability on a per-share basis. It enables investors to determine how much profit is attributed to each share they own. EPS is widely used to compare the profitability of companies within the same industry.

What is the basic formula for EPS?

The formula for basic EPS is:

Earnings Per Share = (Net Income – Preferred Dividends) / Average Outstanding Shares

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.