In CNBC or ET Now every day you listen to a term called EPS. Now, what is EPS? The full form of EPS is Earnings Per Share. But what is the earnings per share importance for stock market investors? Why is the term EPS so important for someone going to invest in a stock for the long-term? All the answers are discussed here.
What is EPS or Earnings Per Share?
Earnings Per Share is the net earnings of the company divided by the number of shares of the company. So it’s a per share version of the performance of the company in terms of its profits. So another word for Earnings Per Share can be Profits Per Share. The main question the investor wants to know before investing in any company is “what’s your profit?”
Example
Company X sells 100,000 units during this year. This is resulting in a net profit of Rs 250,000. The shareholders of the company are entitled to distribute this profit among themselves. If the company has 250,000 outstanding shares then distributing the whole profit among shareholders shows that every share will have a profit of Rs 1. This measurement is earnings per share or EPS.
If next year, the company has a net profit of Rs. 1,000,000, the EPS would be Rs.4 (I.e. Rs. 1,000,000 divided by 250,000).
EPS or Earnings Per Share FAQ
EPS is a part of a company’s profit. It is allocated to each individual share of stock. The main implication is the higher the earnings per share of a company, the better is its profit-making chance. When you calculate the EPS, it is advisable to apply the weighted ratio, as the number of outstanding shares may change over time.
A company that carries high earnings per share ratio is able to generate a high dividend for investors. Otherwise, the company may invest the funds back into its business for more growth. So, in either case, a high ratio shows a potentially worthwhile investment. It depends on the market price of the stock.
The price of a stock will not automatically up or down just based on EPS gains. Buybacks occur once a company repurchases its own company’s shares. EPS then rises as net income is being divided by lesser numbers of shares. But the market’s reaction to buybacks is often mixed.
Here, you need two financial statements to measure earnings per share or EPS. You just need the net income and also preferred stock dividends (if there is any). It is from the income statement, as well as the common outstanding shares. This may be found in the shareholders’ equity section of the balance sheet.
So we will look for a company with good EPS while the cash flow is also of utmost importance. We use EPS to calculate two important values of the growth of the business.
EPS or Earnings Per Share Benefits
The growth of EPS (earnings per share) over a period of 10 years.
The margin of safety analysis. It’s like if I pay Rs. X as EPS
1) The growth of EPS over a period of 10 years
2) The margin of safety analysis. It’s like if I pay Rs. X as EPS, how many days or years will it take to get my money back from the profits of the company. This is also called the payback time analysis.
Limitations
The main problem in Earnings Per Share is it is calculated using a specific system. The calculation is such that you show you get to pay even if you don’t get pay, and as if you have paid all of your expenses even if you pay them later. There is a really good reason why the accounting system for calculation is such.
Because there are instances where companies are having pretty good Earnings Per Share, still they got broken. The reason for the failure of such companies is they did not actually have cash.
Conclusion
These are two utmost reasons for Earnings Per Share importance for the investors. So EPS along with the cash flow is most important to understand the value of the business.
