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Hey there! On the finance express! Today, let's make this a fun and simple journey to learn about Earning Per Share (EPS). Don't despair, we'll avoid using finance jargon and break it down for you in an easy to relate to manner. At the end of this article you'll feel like an EPS expert! So, let's take a dip in the chai and…
What is Earning Per Share (EPS)?
Per share, in essence, is a company's report card. Grades indicate students' success in school, and EPS indicates the profit generated by a company for each investor share. It's a method of figuring out the quantity of bang for every your buck when investing in a specific company.
Suppose company X earned $1,000,000 this year and had 1,000,000 shares issued, then its earning per share would be $1. It's a very simple calculation and will give you an idea of just how productive a company is in making money.
Why is EPS Important?
The question you may ask yourself is, "Why should I care about earning per share? Great question! Investors should find EPS useful to compare companies in the same industry. If Company A has an EPS of $2 and Company B has an EPS of $1, it can be recommended that Company A is more profitable. However, there's a catch! EPS is one of the ingredients for investing.
How is EPS Calculated?
Earning per share (eps) is as easy as pie. Here’s the formula:
EPS = Net Income - Dividends on Preferred Stock / Average Outstanding Shares
Let's take a look at that one a little further:
- Net Income: The profit that the company has after all expenses have been deducted.
- Dividend on preferred stock: Preferred shareholders receive these. That's what company bosses have to put aside before undertaking to determine how much profit belongs to common stockholders.
- Average Outstanding Shares: The average outstanding shares in the period covered is the number of shares available for the public during the respective period.
Suppose that Company Y’s net income is $1 million, and that there are 500,000 shares of common stock in existence, with no preferred stock dividends paid. The equation we used is:Our equation is:
The Different Types of EPS.
Now, let's get down and dirty with the various types of EPS that may arise during your investment career. Knowing these types will guide the decision making process!
1. Basic EPS
This is the basic EPS that we've been discussing. It provides you with the fundamental profitableness of the current shareholders.
2. Diluted EPS
Now, this is where it gets a little technical (not too technical I promise). Diluted EPS adjusts for all potential shares that might be available, such as options, convertible securities and warrants. If they're considering growth and cutting back on shares, you'd want to be interested in this figure in order to keep track of how this impacts their earnings per share.
In the early stages, new investors typically should start with Basic EPS, and should watch Diluted EPS in later stages of the year to get the full story.
EPS and Equity Share.
Let's now move on to a term that is frequently tossed around in the context of Earnings per Share (EPS) conversations: equity shares. Simply put, equity shares, or ordinary shares, are the most common type of shares sold by companies. The equity shares are a form of a company's ownership and when you purchase them you are essentially buying a portion of the ownership of that company. Your investment will reflect the profit (or loss) that the company makes, and this will be done by means of the EPS.
If a company performs exceptionally and its EPS improves, chances are that the equity share price will increase as well. That’s a win-win!
The relationship between EPS and Share Price
Things get interesting here. The Price-to-Earnings (P/E) ratio may be mentioned by investors. This number provides a glimpse at the price that investors are willing to pay for a dollar of the company's earnings. It is worked out using this formula:
P/E (Price to Earnings) ratio is price of the share divided by the earnings per share.
Therefore, if a company has a share price of $20 and an earning per share of $2, the company would have a P/E ratio of 10. This indicates that investors will pay $10 per $1 of earnings. A low P/E ratio could mean that the stock is undervalued, and a high P/E ratio could mean that the stock is overvalued. If you are just starting to invest, then you might want to take the time to learn about P/E ratios as well as Earnings per Share to help you determine if you are investing in a good deal or not!
Understanding the misconceptions that are common about EPS.
Many beginners often misunderstand earning per share. But let's dispel a few misconceptions:
1. EPS Equals Profit
No, not quite! EPS tells us how much profit per share a company is making, but it doesn't tell the whole story.
Higher EPS Always Wins
While an increased EPS might be attractive, it's important to keep in mind the context, such as the company's growth prospects, market standing, and general fiscal state.
3. EPS is a Complete Measure
Don't forget, EPS is only the beginning! Use it in conjunction with other indicators, such as return on equity (ROE) and debt ratios, to get a comprehensive view of a business's financial well-being.
Conclusion: Embrace the Earning Per Share Journey
That's it - a simple explanation of EPS for the beginner! If you are planning to invest in equity shares, or simply wish to seem knowledgeable in discussions, it's essential to have an understanding of EPS. It assists you to determine if a business is a good investment according to its profitability.
So as you proceed on your financial journey, keep in mind that EPS is just one of the multiple tools in your investment toolbox. Make sound financial choices, taking into account a wide variety of factors.
Now you can relax and enjoy your investment day and remember, the share price is only the beginning of understanding the fascinating world of equity shares!
Happy investing!
