Earnings per Share (EPS)
Earnings per share as the name suggest tells the earnings earned by each share invested in the business. EPS
is the only ratio which, for companies listed on stock exchange, is compulsory (under reporting standards) to be presented in Financial Statement of the companies. A complete standard (IAS -33 under International Financial Reporting Standards), therefore, is issued for providing guidance regarding calculation of the EPS.
Earnings per share =
Earnings Attributable To Ordinary Equity Shareholders
Weighted Average of Ordinary Shares
For calculation of this ratio there are two separate figures to consider i.e.
- In numerator: Earnings attributable to Ordinary Equity Shareholders mean the income earned by ordinary shares. The earnings during the year (which is profit after tax in Statement of Comprehensive Income) is normally attributable to Ordinary as well as Preferred Stock Holders. If this is the case then subtract the earnings (that are attributable to Preferred Shareholders) from profit after tax.
- In denominator: Weighted average of Ordinary Shares outstanding during the year means that ordinary shares should be calculated based on time weighted. Time weighted means that if ordinary shares were outstanding from opening then these should be weighted for 12 months, if some share are issued during the year e.g. on 1st June where 31st December is year end, then time weight for these shares is 7 months (31st December – 1st June) and so on. Moreover bonus issues and right issues should also be taken into consideration (IAS 33 of IFRS provides full guidance).
However normally this ratio is already calculated by accountants and presented in statement of comprehensive income, therefore you may not need to indulge in complex calculations of EPS, just pick the figure and use it for your analysis.
Earnings per share =
Data used in calculating ratio is extracted from Hypothetical Financial Statements. (See Hypothetical Financial Statements used in calculation).
EPS (ratio) is measured in Dollars.
Using the above example, the company has earned 5.64 dollars this year for each $1 invested in ordinary equity shares.
How to interpret the ratio
Earnings per Share as already explained is the measure of earnings earned by ordinary shares during the year. However EPS is more meaningful when a trend analysis of 5 – 10 years of EPS is studied, because the trend of earnings shows what the company is earning from some years. It is quite possible that one year earnings are very good but in next year earnings goes bad. Thus decision should not be made based on mere one year EPS instead an understanding of what the company is consistently earning will be a better choice for making decision.
With EPS another concept of Diluted EPS is attached. Diluted EPS calculates the impact of potential ordinary shares that will be converted in future time for which the company has agreed today (e.g. bond issued today will be converted into ordinary shares after 5 years). Diluted EPS is also discussed in IAS 33 in details.
Users’ needs addressed by the ratio
Existing Shareholders want to know what their investment has earned during the current year and whether it is more or less from last year. This way existing shareholder gets some idea of company’s performance during the year.
Potential Investors will invest only if they have handsome return on their investment. EPS shows the trend of company’s earnings. Thus decision making becomes easier for them. Potential Investors normally study EPS with another ratio called Price Earnings Ratio.
Management monitors the EPS to control its performance since management is primarily responsible for using the assets of the company with great efficiency for generating sufficient profits. This ratio tells management where they are standing at the moment and what they should do to improve it.
(You must have an understanding of users’ needs of financial statements; please refer the topic 1- financial statement users for details).
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