Earnings Per Share (EPS) – Meaning, Types, Importance & Limitations

Earnings per share or EPS is a common metric used to carry out corporate value. It can be defined as the value of earnings per outstanding share of common stock of the company.
EPS indicates the company’s profitability by showing how much money a business makes for each share of its stock. The EPS figure is determined by dividing the company’s net profit by its outstanding shares of common stock.
However, it is considered the higher the EPS number, the more profitable the company.

Earnings per share are calculated by dividing the company’s net income by the total number of outstanding shares. Generally, they are calculated in two different ways:
1. Earnings per share: Net Income after Tax/Total Number of Outstanding Shares
2. Weighted earnings per share: (Net Income after Tax – Total Dividends)/Total Number of Outstanding Shares
For instance, a company AB has a net income of Rs. 2 lakh and must also pay Rs. 4 lakh as dividends and has an Rs. 4 lakh weighted average of the shares.
Therefore, the EPS of AB would be –
= Rs. (2 lakh – 4 lakh)/8 lakh
= Rs. 1 per share

There are five different types of EPS:

• Reported EPS or GAAP EPS
• Ongoing EPS or Pro Forma EPS
• Retained EPS
• Cash EPS
• Book Value EPS

• Reported EPS or GAAP EPS

It is achieved by using the Generally Accepted Accounting Principles and is disclosed in the SEC filings. However, a company’s earnings can be distorted by GAAP.
If the income is generated through the one-time payment as operating income as per GAAP, it could shoot the EPS upwards. If a business considers regular expenses as an unusual expense, it will directly boost the earnings per share artificially.

• Ongoing EPS or Pro Forma EPS

It is based on ordinary net income and excludes income generally passed as an unusual one-time income. Thus, it helps discover anticipated income from core business ventures but also does not help with the company’s real earnings.

• Retained EPS

Retained EPS means the company holds the profit rather than distributing it to its shareholders as dividends. Several business owners use the retained earnings per share to pay off existing debts for major purposes like expansion or reserve them for future requirements.
The retained EPS is calculated by adding the net earnings to the current retained earnings and then subtracting the total dividend paid from it. The remainder is then divided by the total number of outstanding shares.
Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares.

• Cash EPS

Cash EPS helps to learn about a particular company's financial standing. It signifies the exact amount of cash earned by the company. It is challenging to manipulate Cash earnings per share. It can be calculated as
Cash EPS = Operating Cash Flow/Diluted Shares Outstanding.

• Book Value EPS

Book Value EPS is used to calculate the average amount of company equity in each share. It can also be used to estimate the worth of a company's stake if it has to be liquidated. It is a static representation of a company's performance as it focuses on the balance sheet.

When it comes to measuring the company's financial standing and profitability, the following points indicate the importance of Earnings Per Share.
1. It helps compare the performance of promising companies to help pick the most suitable investment option.
2. EPS can also be used to compare the financial standing of a company over the years. Companies that have a steady EPS increase can be a reliable investment option. Conversely, companies' irregular EPS are usually not preferred by seasoned investors.
3. A higher EPS means more profitability, which suggests that the company may increase dividend payout over time.
4. EPS not only helps measure a company's current financial standing but also helps track its past performances.

Although Earnings per Share are considered a powerful financial tool, one must remember that EPS has its share of drawbacks. Here are some limitations that both business owners and investors should remember:
1. Most business owners tend to manipulate the EPS to project their venture as profitable frequently. However, most of such attempts are made for the short-term, which often hampers a business venture's image and profitability in the long run.
2. Cash flow is not considered in EPS calculation, which means a high EPS may not accurately signify the company's financial health.
3. Cash flow is an important aspect of gauging a company's ability to repay its debt. However, cash flow is not factored in EPS calculation, which means a high EPS may still prove ineffective for gauging a company's solvency.

• What is Earnings Per Share?

Earnings per share or EPS is a common metric used to carry out corporate value. It can be defined as the value of earnings per outstanding share of common stock of the company.

• Why is Book Value EPS used?

Book Value EPS is used to calculate the average amount of company equity in each share. It can also be used to estimate the worth of a company's stake if it has to be liquidated. It is a static representation of a company's performance as it focuses on the balance sheet.

• What is the major importance of Earnings Per Share?

The major importance of Earnings Per Share is that it helps compare the performance of promising companies to help pick the most suitable investment option.

• How Are Earnings Per Share Calculated?

Earnings per share are calculated by dividing the company’s net income by the total number of outstanding shares. Generally, they are calculated in two different ways:
1. Earnings per share: Net Income after Tax/Total Number of Outstanding Shares
2. Weighted earnings per share: (Net Income after Tax – Total Dividends)/Total Number of Outstanding Shares.

Final Company

Before judging the company’s merit as an investment option, investors must also keep an eye on several other essential factors.
In fact, they should match Earnings Per Share with other various financial parameters to get a fair business idea and its overall scope, profitability, and performance.