Earnings Per Share
EARNINGS PER SHARE (EPS) = (Net income- Preferred dividends)/ Common shares outstanding at the end of the period
Suppose a company has a net income of 50 lakhs and it paid 10 lakhs as a preferred dividend. The company also has 5 lakhs worth of common shares outstanding. Therefore, in this case, the EPS is (50,00,000- 10,00,000)/5,00,000 = 8 per share. However, if the company has convertible securities and all of them gets converted, we calculate diluted EPS. It gives investors the idea of what would be the earnings per share if the holders of dilutive securities exercise their options.
Diluted EPS= Net income/ Current shares outstanding + Exercisable rights on new shares
This ratio helps us to analyse which companies will be more profitable to invest in because a higher EPS generally indicates higher profitability. With the help of this ratio, the investors can also determine the existing and anticipated stock value. In other words, it gives us the idea of whether the stock price is valued as per its market performance or not.
But be careful, not always higher EPS means that the company is suitable for investment. We do not consider the cash flows of the company while calculating EPS. This means, that the company might be quite profitable but could be having poor solvency ratios. Also, the calculation of EPS does not consider inflation too. Therefore, if a company fails to purchase or sell goods more than the previous year, its EPS value might present a misleading picture.
Hence, Earnings per share ratio should be checked with other financial parameters to get a better and overall view of performance of any company.