Earning Per Share is a market value measure and is considered one of the important financial ratio. It is denoted by the symbol EPS. It is calculated by dividing the net profit after tax which is available to the ordinary shareholders by the number of ordinary shares outstanding.
EPS is a market value measure used by almost all the investors to analyze the performance of the entity under consideration. It is the ratio which calculates the amount of net profit available for distribution to the holder of common stock.
Earnings per share = (Net income after tax – preferred dividend) / Weighted average common stock outstanding
ABC income after tax is $ 2,000 while it has 200 ordinary shares in issue.
As we know that:
Earning per share = Net income after tax / number of ordinary shares = 2,000 / 200 = 10
It means that every share earns $ 10 during the year. Please take note that it is the profit and not the dividend amount which people often get confused.
A low EPS ratio is not good because by this shareholders earns a lower amount of profit on their investment. As with any other ration, Earning per share has some flaws with it such as it does not take into consideration the amount of investments by the shareholders. Not just that you cannot compare two companies over the basis of this ratio as this ratio belives that market price per share is same for similar companies. But practically, this is not the case.
An important thing to keep in mind if the company has done share repurchase or stock splits, then this ratio will not be of any significance bacuse you cannot compare the current year's EPS with that of the last year. So, if you do so, your decision will be distorted and will cause severe issues in your strategy formulation process.
Adams & Co. is engaged in shoe manufacturing business and has gained a lot of fame and market share due to its world class manufacturing plant. This plant has also enabled Adams & co to produce the products at a cheap cost as compared to the competitors. Following data is available for Adam & Co financial records:
Profit before tax = $ 100,000
Corporation tax is 30 %.
Share capital $1 each on 01.01.2016 = $ 100,000
Adam & Co has issued 20,000 new shares of $ 1 each on 1st August, 2016.
Calculate EPS (Earnings per share) for the year 2016.
First, we need to calculate weighted average common stock outstanding as follows:
Shares up to 31st July, 2016 = (100,000 x7) / 12 = 58,334 Shares
Shares from 1st August 2016 to 31st December, 2016 = (120,000 x5) / 12 = 50,000
Weighted average common stock outstanding = 58,334 + 50,000 = 108,334 Shares
Net income after tax = 100,000 – 3,000 = $ 97,000
Now, we will calculate EPS as follows:
Earnings per share = (Net income after tax – preferred dividend) / Weighted average common stock outstanding = 97,000 / 108,334 = $ 0.8953