Earnings per Share
(EPS)

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Reported Earnings. Explanation of Earnings per Share. EPS.

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Earnings per Share (EPS) is a traditional method used for determining corporate value. Similar words like EPS are: Accounting Earnings and Reported Earnings, except that EPS is divided by the average number of outstanding shares.


Earnings per ShareEPS calculation

Earnings per Share can be calculated by subtracting the dividends on preferred stock from net income, and dividing the result by the (weighted average of the) combination of all outstanding common shares and all common stock equivalents (see figure on the right).


Fully Diluted EPS

Fully Diluted EPS means that all common stock equivalents (convertible bonds, preferred stock, warrants, and rights) have been included along with the common stock.


A poor indicator of actual corporate value

Reported Earnings are a very poor indicator of corporate value.


Six major reasons why EPS fails to reliably measure the economic value of firms are:

  1. Alternative accounting methods may be employed. Both required changes by FASB or IAS and voluntary changes can change EPS, but do not affect economic value.
  2. Risk is excluded. Both business risk and financial risk are not accounted for in annual reports.
  3. Investment requirements are excluded. Changes in for example the working capital are not considered in Reported Earnings.
  4. Dividend policy is not considered. For example dividend decreases will show increased EPS but are in fact value neutral.
  5. The time value of money is ignored. No present value calculation in Reported Earnings.
  6. The increased role which intangible assets play in our economic system, that has moved from an industrial economy towards a services and knowledge oriented economy.

Despite Enronitis, Earnings per Share is still being widely used in many annual reports.


Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Book: Ciaran Walsh - Key Management Ratios -


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Diluted EPS

 

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Compare with EPS:  EBIT  |  EBITDA  |  P/E Ratio  |  Economic Value Added  |  Cash Ratio  |  Current Ratio  |  Return on Equity  |  Fair Value  |  ROIC


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