The Earnings Per Share Ratio or the EPS ratio is utilized in order to measure the net income of a company which is available to be paid to the holders for the common stock present. Determining whether a company is profitable or not can be done with EPS.
This financial ratio helps investors by providing a method of determining the amount that is earned on the investments of businesses.
What are the different methods that Earnings Per Share Ratio can be calculated?
In order to calculate the EPS of a company, the income statement, balance sheet as well as the net income and the dividends that are paid are taken into consideration.
The weighted ratio is recommended to calculate the EPS as the amount of outstanding shares may vary over certain periods of time.
- EPS = Net income/ Total outstanding shares available
- The weighted EPS = (Net income after tax – Total preferred stock dividends)/ Total outstanding common shares
A company’s EPS should be taken with consideration towards other companies to make an informed decision regarding the investment that is to be done.
An example using the EPS formula would be,
Company X has a net income of $10 million in the third quarter. Dividends of $2,500,000. The total number of outstanding shares would equal 21,000,000.
Company X’s EPS is,
($1000000 – $2500000) / 21000000
$0.357 would be the net income received by each share as it is equally distributed.
What are the different types of EPS ratio?
Reported EPS –
This is also known as GAAP EPS and it is taken from the generally accepted accounting principles and the earnings which may have been reported by a company could have been changed by GAAP.
Retained EPS –
This is the amount of earnings which is kept by the company instead of being shared as dividends. The debts that may be present can be paid off with retained earnings or they could also be used to meet future needs or in order to expand the business.
The formula used is,
(Net earnings + Current retained earnings present) – dividend paid / total outstanding shares available
Pro Forma or Ongoing EPS –
Any unusual event which may be considered as occurring only once comes under this type of EPS. Also known as Pro Forma EPS, it doesn’t include certain expenses or income that were used in order to find out the reported earnings. It does not assist in showing records where the real earnings of a company can be visibly noticed.
Cash EPS –
A company’s standing can be determined and this EPS helps in figuring out the precise amount of cash that has been earned. It is challenging to manipulate it.
The formula for Cash EPS is,
Operating cash flow divided by the outstanding diluted shares.
Book value EPS –
Book value is also known as Carrying value per share. It helps in estimating the company’s share in case it ends up being liquidated. The amount of aggregate equity present in each share can be computed with this type of EPS.
In order to calculate the book value of EPS, the current balance sheets need to be taken into account to find the EPS.
What are the Benefits of EPS ratio?
- It allows investors to analyse and check whether investing in a certain company would bring in higher income as a higher EPS rate shows more profits and this goes to indicate that with time, the dividend of the company may increase.
- It is used to evaluate and price the stocks so that stocks with better EPS get higher prices.
- The best option for investment can be chosen and comparisons of different companies can be done.
- The past market performance and the previous position of the company can also be tracked for investors who want to make calculated investment decisions.
- The future or current stock value of a company can be found out and it helps understand whether the price of the stock has been valued according to the performance in the market.
What are the Disadvantages of EPS ratio?
- EPS can be manipulated and altered by the owners of businesses for short terms in order to make it seem as though their venture would be a beneficial, profitable one to attract investors.
- Cash flow does not get factored while the EPS is being calculated and even if the EPS is growing at a high rate, this may prove to be ineffective when the valuation of a company is done.
- The performance of the company is not taken as the share price is not considered.
- Inflation does not get taken into consideration by EPS and there may be issues when it comes to the accuracy of the growth value that has been shown. This may end up showing an EPS value which is inaccurate.
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