EPS (Earning per share) | Meaning of EPS | Formula | Pros, Cons

WHAT IS EPS ?

EPS known as Earning per share. It tells the investor about the earnings of the company in the past few years or quarters.

It is a fundamental ratio that determines companies earning on each share. It shows the growth and stability of the company's earnings over the year. A constant growth in EPS is good sign for the company. 

EPS can be calculated by dividing company's profit to the number of outstanding shares.

It is the basic formula to understand EPS.

TYPES OF EPS

--) Trailing EPS :

EPS that is evaluated on the basis of last 12 months of trading is known as trailing EPS. It is the average of last 12 months EPS. For example, Hindustan Unilever limited have EPS (TTM) of 28.76.

 Trailing EPS is written by adding TTM after EPS. 

--) Current EPS : The current ongoing EPS is known as current EPS.For example,

 ITC limited has a current EPS of 12.06 and changing. Sun Pharma has a current EPS of 13.02 and changing.

--) Future EPS : The estimates of EPS that are based on the present growth of the company is known as future EPS. For example the future EPS of Hindustan Unilever is estimated to be of 30.31 in the upcoming quarter. 

--) Diluted EPS: diluted EPS is calculated on the basis of net income subtracted by preferred dividend of shareholders upon outstanding shares plus diluted shares. Diluted EPS means EPS when all convertible securities are converted. It means EPS in the worst situation.

--) Basic EPS: Basic EPS is calculated by net income subtracted by preferred dividend upon company's Total outstanding shares. Basic EPS is always more than or equal to diluted EPS.

COMPARISON POINT 

Let us consider two companies, company A and company B. Both having same EPS of 15 rupees each. Company A has a share price of 95 and company B with the share price of 128. The matter of fact is that company A earns Rupees 15 if you invest 95 and company B earns Rupees 15 if you invest 128 in it. In this case, investing in company A is a good choice because it is more efficient as compared to company B. Company A is also good in terms of value for money. So in this case a good buy would be company A.

FURTHER MEANINGS OF  EPS 

There are companies who like to re-invest their profits for growth and scalability. Growth and scalability for such company means to achieve the maximum volume of customers first. Such companies are mostly in IT sectors. For example, new startups such as Ola,Uber, Paytm, OYO rooms etc are not profitable yet.The mindset of modern day entrepreneurs is to build customer base first and then focus on profitability like Amazon.com . 

Let us take an example of Amazon. Getting listed on exchange in 1997, at that particular point of time Amazon was not profitable. Business was just focused on building online customer base. It took 14 years for Amazon to be profitable. For such companies EPS is very poor but that does not mean that a company is not worth investing. At present time, Amazon is the biggest e commerce company in the world, making Jeff Bezos(CEO of Amazon Inc ) world's richest man. In 2009, a share of Amazon was trading at $64. At present in 2019 it is worth over $2300,an increase of 3493% !

--) A continuous growth in EPS means company's profits are increasing and has more money to pay to its shareholders.If there is regular growth in profits, dividend given to the shareholder may also increase.

--) Stocks with continuous growth in EPS are always worth investing. Investors use EPS to compare companies within the same industry to get an estimate of bussiness performance with respect to peers. 

--) EPS plays an important role in calculating price to earning ratio (PE ratio).

LIMITATIONS OF EPS

--) Companies management knows that EPS seeks an important part in investors fundamental analysis. So management wants company's EPS to appear high.

--) EPS figures are irrespective of inflation. EPS disregards inflation. Manufacturing industry requires goods(i.e. raw materials)for processing. Due to inflation raw materials increases in value every year but EPS doesn't show any deduction in figures on account of inflation. According to reports, 100 rupee material in 2019 may cost up to 103.5 in future(2-3 years).If the company's earning are not increasing with respect to inflation rate then the cash flow might turn negative.

--) Each company have different accounting policies and it makes it difficult to understand each company's commerce with their point of view. The accounting policies that may apply for a company may not apply for peer companies.

ADVANTAGES OF EPS

--) One of the biggest advantages of EPS is that it makes it easier to calculate the company's earnings on each share.

--) It plays a small but an important part in fundamental analysis process.

--) It simplifies calculation of what company has earned for investor on account of his investment.

BAZAARWALLA'S THOUGHTS/ADVICE 

One should not buy share just by observing rapid growth in EPS of 2 or 3 quarters.Data of nearly 4 to 5 years of company's performance should be analysed. All the important ratios including EPS, financials and annual report of the company should be carefully interpreted.

EPS just place a part in fundamental analysis of stocks. No decision of investment should be taken just by observing rapid  growth in EPS of any stock.Investing should be a calculated game not a dice game where your future depends upon luck or dice. Last but not the least, analyse the company as if you are the owner of that business.