Earnings per share, or EPS, is a way to express a company’s profits in terms of each stock share owned by its investors. EPS can help an investor make sense of a stock’s price, compare stocks to one another, and analyze a company’s performance and prospects.
There are broadly following two methods as prescribed by Ind AS 33 for computing EPS:
- Basic EPS
This method enables understanding the earnings attributable to each ordinary share. In this method, EPS is calculated as bellow-
EPS = [Profit/ (loss) attributable to ordinary equity holders of the parent entity less post-tax pref. dividend] ÷ Weighted average number of outstanding ordinary shares
The weighted average number of ordinary outstanding shares shall be adjusted for events, apart from the conversion of potential ordinary shares, which have changed the number of ordinary outstanding shares without a simultaneous and corresponding change in resources.
In a capitalization, a share split, or a bonus issue, ordinary shares are issued to existing shareholders for no additional consideration. Thus, the number of ordinary shares outstanding is increased considering such an event at the beginning of the earliest period presented.
- Diluted EPS
The diluted EPS is calculated by adjusting the profit/ (loss) and ordinary shares for all dilutive potential ordinary share effects.
For computing diluted EPS, an entity should assume the exercise of dilutive options and warrants of the entity. The estimated proceeds from such instruments shall be considered as having been received from the issue of ordinary shares at the average market price of ordinary shares during the period.
The dilutive effect of all the convertible instruments shall be accounted for in diluted EPS.
As in the computation of basic EPS, contingently issuable shares are treated as outstanding and included while computing diluted EPS if the conditions are met.
If an entity has issued a contract which can be settled in ordinary share or cash at the entity’s option, it shall presume that the contract will be settled in ordinary shares, and the net resulting potential ordinary shares shall be included in diluted EPS if the effect is dilutive.
For contracts that can be settled in ordinary shares or cash at the holder’s option, the more dilutive of cash settlement and share settlement shall be used in calculating diluted EPS.
Derivative contracts such as put options and call options (i.e., options held by the entity on its own ordinary shares) should not be included while computing diluted EPS because the effect of such inclusion would be anti-dilutive.
Contracts in which the entity is entitled to repurchase its own shares, like written put options and forward purchase contracts, are reflected in the computation of diluted EPS if the effect is dilutive
What does EPS indicate to an investor?
When comparing the earnings per share of different stocks, it’s important to compare companies only within the same industry or sector. EPS helps show how well a company generates profits for every rupee that shareholders invest in and can significantly influence a stock’s price.
Investors might also look at EPS for the single stock over time to help gauge a company’s trajectory. Is EPS growing from quarter to quarter or shrinking?
If a company’s EPS is higher than that of its competitors, or on an upward trend, that may be a sign that the company can increase dividend payments or invest more to grow its business.
Earnings per share are used to calculate another key stock analysis figure: price to earnings ratio, or P/E ratio. The P/E ratio is a good indicator of the health of a company as expressed through earnings. This is calculated by dividing the stock price by EPS. If the market price of our XYZ Corporation stock is Rs1500 when the company’s EPS is Rs15, then the P/E ratio is 100. The stock is selling for 100X more than its earnings per share. An investor might use this to help judge whether a stock is overpriced or underpriced or to compare the performance of stocks within the same industry.
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