Overview Of Earnings Per Share
Earnings per share equals to the net income a company generates per share of the company. It is an important indicator of the profitability of a company and is widely used by analysts and investors before making a decision regarding investments in the shares of a company. Typically a higher Earnings per Share ratio is desirable. It means that the company is more profitable as it is indicative of the amount, in theory, available for payment to common shareholders.
Earnings per share are calculated as follows-
Earnings per share = Net Profit after Tax/Total Number of Outstanding Shares of the Company
The numerator for the ratio is derived from the profit and loss statement for the year, which is in accordance with the generally accepted accounting principles. It is important to note that Net profit is arrived at, after deducting the applicable tax. Dividend paid to reference shareholder is also deducted from the numerator before computing the ratio.
The denominator of the ratio comprises the number of average shares of common stock outstanding and not the average common stockholders' equity.
Earnings per Share can also be calculated as
Weighted earnings per share = (Net Profit after Tax - Total Dividends)/Total Number of Outstanding Shares
Let us take a numerical example:
The following financials are of ABC Company for the year 2015.
Net Profit after Tax = USD 1,700,000
As on 31st December 2015
5.5% cumulative preferred stock outstanding = USD 3,500,000
USD 10 par value common stock outstanding 2015 = USD 2,380,000
During the year, the company has not issued neither issued common non preferred stock and hence the stock holding remains the same during the year.
Based on the financial above, Earnings Per share can be calculated as:
Net Profit After Tax Less Dividend on Preference Shares = 1,700,000 - (5.5% * 3,500,000)
Net Profit after Tax less Dividend on Preference Shares = 1,507,500
Total Number of Outstanding Shares = 2,380,000/10
Total Number of Outstanding Shares = 238,000
Hence the Earnings per Share = USD 6.33 per share
In others words, it means that for one common stock held, the shareholder is entitled to USD 6.33 of net profits, in theory.
Sometimes, Earnings per Share is also includes convertible shares as well as warrants while taking the outstanding shares figure. The Earnings per share ratio is also indicative of the amount of flexibility a company has in increasing its dividend payouts. However some companies might be deploying extra cash available with them in the business for growth and expansion purposes. Further the ratio cannot be looked at on a standalone basis. For the same company it is important to observe the ratio over a period of time, if it is increasing it means the company is either earning more for every shareholder or it could be due to reduction in base of the number of shares. Similarly a declining trend in the ratio also needs to be probed into.
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