Understanding EPS (Earnings Per Share) Ratio
Earnings Per Share (EPS) Ratio is a valuation metric that measures how much money a company makes on a per share basis. EPS is calculated as net income divided by weighted share outstanding. This metric indicates the company's ability to generate net profits for common shareholders.
For investors, EPS is one of the important financial metrics as it indicates the company's earnings and profitability. And this metric is used in many financial metrics like, Price to Earnings (PE) Ratio, Earnings Yield, Dividend Payout Ratio, etc.,
The formula to derive EPS Ratio
Net Income - Net Income or Net Profit is measured by sales minus the Cost of goods sold, general and administrative expenses, operating expenses, other expenses, depreciation, interest, and taxes, etc. Net Income is found in the
Income statement of the companies.
Weighted Share Outstanding - It is the number of shares the company calculates after adjusting changes in share capital during the year. The number of shares can vary during the year due to multiple reasons like buybacks of shares, new issues of shares, stock splits, conversion, etc. It is used because it provides a fair EPS value.
Example of EPS: Aurobindo Pharma Limited Reported Net Income of previous four quarters (last 12 months) as Rs. 5215 Cr. And Weighted Share Outstanding as Rs. 58.59.
The value as per the formula (Net Income / Weighted Share Outstanding) is calculated as (5215 / 58.59) = 89.00.
Key Highlights
EPS is calculated as net income divided by weighted share outstandings. It is a valuation metric that measures how much money a company makes on a per share basis.
If the company generates high Net Income then EPS will be higher, and opposite to this, low net income results in lower EPS.
EPS often changes, depending upon the two factors that are net profits of the company and the number of weighted outstanding shares.
While looking at the EPS ratio, the following points should also take into consideration:
The high EPS indicates a company is profitable. Earnings Per Share matter a lot to investors as strong earnings are inclined to drive the price per share up, and it is considered a plus point.
As the number of weighted outstanding shares can change over time, it is advisable to use the weighted average when calculating the EPS.
This metric indicates the company's earnings capability. It shows how much a company is making profits on one common share.
EPS is inverse relation to its weighted outstanding shares. If the company's weighted outstanding share increases then, the EPS number will decrease.
And if weighted outstanding shares decrease then, the EPS will increase.
EPS often changes, depending upon the two factors that are net profits of the company and the number of weighted outstanding shares.
How to use EPS effectively
Investors should look for higher earnings per share (EPS); it indicates that the company is profitable. But investors should check other dilemmas for analysis.
Two companies are company A and Company B, and their EPS is the same, but company A is generating net income equal to company B but with less amount of capital then it indicates that company A is more efficient and profitable.
Investors should compare the current year's EPS of the company with its historical EPS. By checking EPS of one year will not give a brief understanding. If the EPS is continuously growing year-over-year is a plus point.
For better analysis investors should check other financial metrics relative EPS like
PE ratio,
PB ratio,
Earnings Yield,
Dividend Payout Ratio,
Enterprise Value to Revenue,
Net Margin, etc.,
Factors that affect EPS
If the company generates high Net Income then EPS will be higher, and opposite to this, low net income results in lower EPS.
For the particular quarter, if the company issues more shares, then earnings per share will decrease. Because in this scenario, the same amount of profit the company has to divide between more shares.
And if the company reduces the number of shares while maintaining the identical profit level, the EPS will increase. In this kind of scenario, the same amount of profit the company has to divide between less shares.
Many companies issue Employee Stock Ownership Plan (ESOP) for their employees, warrants and convertible securities, etc. And when these kinds of convertible securities convert into equity shares, then weighted outstanding shares increase, and due to this EPS decreases.
