Earnings per share (EPS)
Earnings per share is profit earnings per outstanding common share. In other words distribution of profit of company to each outstanding common share. It indicates the profitability of the company. Which helps to find intrinsic value of a share.
Earnings per share – Formula
EPS = ( Net Income – Dividend on preferred shares ) / Average value of outstanding shares
Earnings per share – Calculation
Calculation of EPS is not straightforward as shown above. Above shown way is only for basic and education purpose. In order to calculate EPS of a company, income statement and balance sheet plays important role to find total number of outstanding shares. Balance sheet presents profit or net income and dividends on outstanding equity shares. While calculating EPS accurately, usually weighted average number of outstanding shares over the term is useful. Since number of outstanding shares change overtime.
Any occurrences of the stock splits and dividends issued must and should reflect in this weighted average number calculation of the outstanding common shares. However sometimes data sources, like websites or paper media consider calculating these weighted average at the end of the period.
Earnings per share – Importance
EPS plays very important role in finding intrinsic value of a share. It is also very important to calculate Price to earnings ratio ( P/ E ). Where ‘E’ represents EPS and ‘P’ represents current market price of the share. P/E changes with respect to current market price of the share.
In other words P/E can be defined as how much price investor is willing to pay for the respective share. Most of the professional investors prefer both EPS and P/E ratios to evaluated actual price or intrinsic value of the stock.
Usually investors prefer shares which have P/E gradient in between 8 to 20. Companies with P/E less than 8 is not good for investment. Also companies with P/E more than 20 is overvalued.
P/E ratio is help full in order to calculate PEG ratio.