The earning per share can be ear rated into an Earnings Per Share (EPS) amount, which is useful in evaluating the price or common stock.
Earnings per share are the measures that provide reliability to equity shareholders as a per-share basis the amount that they can get every share hold. The earnings per share represent the number of dollars earned or be help of each outstanding share of common stock.
| Formula: Earnings Per Share (EPS) = Net income / Net sales |
EPS is simply the net income attributable to common shareholders divided by the number of shares outstanding.
If a company has a complex capital structure, a portion of its dilutive securities may be converted to equity at some point in time.
Since EPS essential does not take into account these dilutive securities, EPS basic will always be greater than EPS fully diluted.
What principles need to compute EPS for an analyst?
The analyst must have thought to understand the principles that govern the computation of EPS. The need for;
- Evaluation of Dividend coverage.
- Dividend-paying ability.
- Purpose of paying dividends.
- Considering about Net Income.
Dilution effects on Earnings per share
EPS dilution means a reduction in EPS resulting from the assumption that convertible securities have been converted into common stock, or those options and warrants have been exercised, or that shares have been issued in compliance with certain contracts.
| Dilutive > When decrease EPS Anti-dilutive > When increases EPS |
Only dilutive securities are included in the diluted EPS calculation.
What is Anti-Dilution
The use of proceeds that would be obtained upon excise or options and warrant in computing EPS.
Anti-dilution is an increase in EPS resulting from the assumption that convertible securities have been converted or that options and warrants have been exercised or other shares have been issued upon the fulfillment of certain conditions.
Provisions Regarding Anti-dilution
As with primary EPS, no anti-dilution should be recognized. Consequently, computations should exclude those securities whose conversion, exercise, or other contingent issuance would have the effect of increasing the EPS amount or decreasing the loss per share amount for each period.
Fully Diluted EPS
Fully dilutive EPS is designed to show the maximum potential dilution of current EPS on a prospective basis. Fully diluted EPS is the number of current EPS reflecting the maximum dilution that would have resulted from conversions of all convertible securities, whether they are CSE or not, as long as they are dilutive.
Fully diluted EPS are also intended to reflect dilution resulting from exercises and other contingent issuances that individually would have been decreased EPS and in the aggregate would have had a dilutive effect.
When Fully Diluted EPS is required, and how is computed?
Fully diluted EPS data are required for each period presented, and if shares of common stock,
- Was issued during the period on conversions, exercise, and so on.
- Were contingently issuable at the close of any period presented, and if primary EPS for such period would have been affected had such actual issuances take place at the beginning of the period.
Computation of Fully Diluted EPS
The computation should be based on the assumption that all such issued and issuable shares were outstanding from the beginning Of the period (or from the time the contingency arose, if after the beginning of the period.
Interest charges applicable to convertible securities and nondiscretionary adjustments that would have been made to items based on net income or income before taxes – such as profit-sharing expense, certain royalties, and investment credit – or preferred dividends applicable to the convertible securities should be taken into account in determining the balance of income applicable to common stock.
EPS can affect the market prices of common stock. Can market prices affect EPS
Although stock options and warrants (and their equivalents) and stock purchase contacts should always be considered CSIj, they should not enter into EPS calculations until the average market price of the common stock exceeds the exercise price of the option or warrant for preferably three consecutive months before the reporting period.
Computations of primary EPS should not give effect to CSE or other contingent issuance for any period in which their inclusion would have the effect of increasing the EPS amount or decreasing the loss per share amount otherwise computed.
Stock Price vs. EPS
While a company’s EPS will often influence the market price of its stock, the relationship is rarely inverse. The company’s EPS is determined by dividing the earnings by the number of outstanding shares.
The market price of each share is immaterial.
For example, a company might have 1 million shares of stock outstanding. If that company earns $1 million, its EPS is $1. It doesn’t matter if the market price for the stock is $10 per share or $100 per share.
Differentiate between Basic Earnings Per Share (EPS) and Diluted Earnings Per Share (EPS)
The difference between Basic EPS arid Diluted EPS are given below;
| Aspect | Basic Earnings Per Share (EPS) | Diluted Earnings Per Share (EPS) |
| Definition |
Basic EPS is simply the net income that is attributable to common shareholders divided by the number of shares outstanding. Earnings per share are the measures that provide reliable to equity shareholders as a per-share basis the amount that they can get an | EPS dilution means a reduction in EPS resulting from the assumption that convertible securities have been converted into common stock, or those options arid warrants have been exercised, or that shares have been issued in compliance with certain |
| Nature | Basic EPS are always considered in the calculated result. | Diluted EPS are always considered to decrease level. |
| Part | It is part of the simple capital structure. | It is also a part of the complex capital structure. |
What are the additional required disclosures for the presentation of EPS?
Complex capital structures require additional disclosures either on the balance sheet or in notes.
About Earnings Per Share (EPS) data, disclosure is required for:
- The bases upon which both primary and fully diluted Earnings Per Share (EPS) are calculated, identifying the securities entering into computations.
- All assumptions and any resulting adjustments used in computations.
- The number of shares issued upon conversion, exercise, and so on, during at least the most recent year.
Supplementary Earnings Per Share (EPS) data should be disclosed if:
- Conversions during the period would have affected primary EPS (either dilutive or incremental effect) if they had taken place at the beginning of the period, or
- Similar conversions occur after the close of the period but before completion of the financial report’.
What is supplementary EPS? How are they disclosed?
Supplementary information should show what primary EPS would have been if such conversions had taken place at the beginning of the period or date of issuance of security if within the period.
Supplementary EPS data should be disclosed if:
- Conversions during the period would have affected primary EPS (either dilutive ‘or incremental effect) if they had taken place at the beginning of the period, or
- Similar conversions occur after the close of the period but before the completion of the financial report.
APB Opinion 15 has several flaws and inconsistencies that the analyst must consider in the interpretation of EPS data. Discuss these
APB Opinion 15 has several flaws and inconsistencies that the analyst must consider in his interpretations of EPS data:-
- There is a basic inconsistency in treating certain securities as the equivalent of common stock for purposes of computing EPS while not considering them as part of the stockholders’ equity in the balance sheet.
- There are several arbitrary benchmarks in the Opinion, such as the 20 percent treasury stock repurchases assumption limitation and the 662/3 percent of the average AA corporate bond rate test.
- The Opinion considers options and warrants to be CSE at all times, and whether they are dilutive or not depends on the common stock price. Thus, we can get a circular effect in that the reporting of EPS may influence the market price, which, in turn, influences EPS. Also, under these rules, earnings may depend on the market prices of the stock rather than only on economic factors within the enterprise.
- Since the determination of whether a security is a CSE or not is made only at the time of issuance, it is quite possible that a security that was not originally a CSE is later so organized in the marketplace. Nevertheless, the status of protection in the computation of EPS cannot be changed to recognize the new ‘reality.
How does the payment Of dividends on preferred stock affect the computation of EPS?
Earnings per share (EPS) is a key figure in finance. It measures how much profit the company made for each common stock.
Common stock is the most basic ownership unit in a corporation and entitles the owner to receive a portion of the company’s profits. Common stockholders keep a close eye on Earnings per Share (EPS) because the more the company earns, the more that can be paid as dividends.
Preferred stockholders, on the other hand, are paid a fixed amount per stock every year, irrespective of the company’s profits.
Since preferred shareholders must be paid in full before common stockholders can receive any dividends, you must subtract preferred dividends from the company’s net income to compute Earnings per Share (EPS) for common stock.
Preferred vs. Common Stock
Large corporations tend to issue two types of shares: common arid preferred stock. Common stock entitles the owner to vote in the annual shareholder meeting. In contrast, the members of the board of directors are elected, and other major issues, such as mergers with other companies, are opened to a shareholder vote.
Common shareholders also receive a portion of the company’s profits if the board decides to distribute a common stock dividend.
Preferred stockholders cannot vote in the shareholder meeting and are entitled to a fixed annual payment for each preferred stock they hold. No matter how much money the company makes, preferred shareholders cannot receive more than this fixed sum.
Preferred Dividends
Each preferred stock carries a face value and a coupon rate. The face value is the original issue price of the stock, while the coupon rate is the percentage of the face value the stockholder will be paid every year.
If, for example, the stock has a face value of $50 and a coupon rate of 8 percent, the holder of one such stock will be paid 8 percent of $50, or $4, every year. If the issuing company is making a single coupon payment every year, the stockholder will receive $4 once. In the case of semi-annual coupon payments, the stockholder will be paid $2 per stock twice a year.
Preferred Status
The reason preferred stocks are given that name is that they have priority over common stock. The company cannot legally pay a dividend to common shareholders until preferred stockholders are paid in full. In case of bankruptcy proceedings, too, preferred shareholders must receive the full face value of their shares before common stockholders can be paid any money from the asset sales.
Therefore, you must determine the net amount owed to preferred stockholders and subtract this figure from net income. Only then will you arrive at the amount of profit that can legally be distributed to common stockholders.
Example of Preferred Status
Assume the company earned $10 million during the last year and has 2 million common shares and 1 million preferred shares.
Further, assume that each preferred stock has a face value of $50 and a coupon rate of 8 percent. Let’s calculate the EPS for common shares. Keep in mind that EPS is only relevant for common stockholders since preferred stockholders already know what they will receive. Each preferred stock will be paid $4 per year.
The total cash payable to all preferred stockholders is 1 million times $4, or $4′ million. Subtracting this figure from the company’s net earnings results in $6 million. Six million divided by 2 million, the number of common shares, results in an EPS of $3 for common stock.