Thursday, November 12, 2009

Earnings Per Share (EPS)

It has been quite a few days that I posted here. I was actually not able to decide where to start.After due diligence, I decided to start with the most basic of the fundamental tools: THE EPS a.k.a. Earnings per Share.

Why is EPS so Important

While evaluating two companies, one needs to compare the companies on a common basis. We can't compare them on the basis of their market price as that changes daily and also doesn't represent the total worth of a company. Consider company A having only 100 shares of Rs 10000 each and company B with 10000 shares of Rs 1000 each. Obviously, Company B is the bigger one in size!

Similarly, comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Using the raw numbers ignores the fact that the two companies undoubtedly have a different number of outstanding shares. For example, companies A and B both earn Rs 100, but company A has 10 shares outstanding, while company B has 50 shares outstanding.

EPS comes for your help here! In the above example, Company A has an EPS of 10 as compared to 2 for Company B, making Company A as more profitable for the stock holder. So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some ratios (My next Post). Today, we would only concentrate on EPS.

The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.
Calculated as:

Earnings Per Share (EPS)

There are 3 kinds of EPS:

  • Trailing EPS – last year’s numbers and the only actual EPS
  • Current EPS – this year’s numbers, which are still projections
  • Forward EPS – future numbers, which are obviously projections
Diluted EPS

expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. This is because all of these can be converted into shares at a particular date. This reduces the EPS value making the stock look more expensive.

In most cases, the diluted earnings-per-share figure is far more accurate estimation of the total earnings per share and receive special attention when valuing a company.

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