Understanding Earnings per Share

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One of the most popular questions when it comes to buying a car is 'Kitna deti hai’? (What is the mileage of the car?)

Fuel efficiency of the car is calculated as the distance travelled per unit volume of fuel consumed. During heavy traffic the mileage of your car will be less as compared to empty roads. It all depends on the distance covered per litre of fuel consumed. Therefore, the distance travelled is a major factor defining the fuel efficiency of a car.

Better fuel efficiency would mean higher savings while poor fuel efficiency would mean higher expenses.

Here's a lesson on ‘Earnings Per Share’ that draws a similar analogy to fuel efficiency

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Understanding Earnings per Share

  1. 1. EARNINGS PER SHARE (EPS)
  2. 2. EPS or Earnings Per Share is the portion of the company’s distributable profit which is allocated to each outstanding equity share. EARNINGS PER SHARE (EPS)
  3. 3. A company’s EPS is calculated as: Net Profit for a period Number of Shares =
  4. 4. That means, if Company ABC has posted a net profit of Rs. 1,000 and it has a total of 100 shares, its EPS will be Rs. 10 per share. EARNINGS PER SHARE (EPS)
  5. 5. EARNINGS PER SHARE (EPS) So what are the different types of Earnings?  Earnings can be sub-divided further according to the time period involved.  Earnings can be assessed by  Trailing - Prior earnings  Current - Recent earnings  Forward - Projected future earnings
  6. 6. Why EPS? EARNINGS PER SHARE (EPS)
  7. 7. EARNINGS PER SHARE (EPS)  EPS is the amount of money each share would receive if all the profits were distributed to the outstanding shares at the end of the year.  EPS helps compare two companies. Higher EPS is better than a lower EPS because this means the company is more profitable and has more profits to distribute to its shareholders.  EPS is also a key driver of share prices.  It is also used as the denominator in the frequently cited P/E ratio.
  8. 8. EARNINGS PER SHARE (EPS) Let’s consider a simple example: Company X and Y have earned a profit of Rs. 150 each. However, Company X has 75 shares outstanding and Company Y has 100 shares outstanding, which one would you prefer? Your answer lies in the EPS figure. Company X has an EPS of 2 (150/75) whereas company Y has an EPS of just 1.5 (150/100). So you prefer the company X that pays you more profit per share than Company Y.
  9. 9. When does EPS increase?
  10. 10.  An increase in a company’s EPS doesn’t necessarily mean that the profitability has gone up; profits can also remain flat or even fall.  It could be because of changes in capital structure like a buy-back programme or merger & acquisition, due to which the number of shares has reduced.  All this would result in an increase in EPS. Suppose, the profit of Company ABC reduces to Rs. 900 and total number of shares reduce to Rs. 85 due to its share buy-back. Here, the EPS would go up to Rs. 10.59 per share. (As compared to earlier example on Slide 4). Earnings Per Share (EPS)
  11. 11. When does EPS go down?
  12. 12.  Just like the increase in EPS, a dip doesn’t mean that the profitability of a company has gone down.  A public offer or an activity to raise fresh capital could decrease the EPS. Even share splits can reduce the EPS. Let’s assume that the profit of Company ABC goes up to Rs. 1,100 and it raised its total number of shares to 120. This would mean the EPS would go down to Rs. 9.17 per share, while the company remains profitable. Earnings Per Share (EPS)
  13. 13. How to use EPS?
  14. 14.  Remember, EPS should not be the only measure to influence your decision.  If you own a stock whose EPS has fallen, you should not be in a hurry to exit.  When deciding whether to stay invested or not in a stock that has witnessed a fall in EPS, you should identify the reason behind the decline. Earnings Per Share (EPS)
  15. 15. Let us see the formulaof the CurrentAccountBalance (CAB) CAB = X -M + NI+ NCT X = Exports of goods and services M = Importsof goods and services NI = Net income abroad [Salariespaid orreceived, credit /debitofincomefrom FII&FDIetc.] NCT= Net current transfers [Workers'Remittances (unilateral),Donations, Aids& Grants,Official, Assistance and Pensionsetc] CURRENT ACCOUNT DEFICIT Hope you have understood the concept of ‘Earnings Per Share’. EARNINGS PER SHARE (EPS)
  16. 16. Please give us your feedback at professor@tataamc.com
  17. 17. DISCLAIMER The views expressed in this lesson are for information purposes only and do not construe to be any investment, legal or taxation advice. The lesson is a conceptual representation and may not include several nuances that are associated and vital. The purpose of this lesson is to clarify the basics of the concept so that readers at large can relate and thereby take more interest in the product / concept. In a nutshell, Professor Simply Simple lessons should be seen from the perspective of it being a primer on financial concepts. The contents are topical in nature and held true at the time of creation of the lesson. This is not indicative of future market trends, nor is Tata Asset Management Ltd. attempting to predict the same. Reprinting any part of this material will be at your own risk. Tata Asset Management Ltd. will not be liable for the consequences of such action. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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