WHAT IS THE IMPORTANCE OF ‘EARNINGS PER SHARE /EPS’ AND HOW ‘THE CASH EARNINGS PER SHARE /CEPS’ IS DIFFERENT FROM THE ‘EPS’

Earnings Per Share (EPS) different from the Cash Earnings Per Share (CEPS) in the similar manner as that of Cash Flow is different from the Net Income.

Basic Earnings Per Share is the function of Net Income of a Company. Whereas, CEPS is a function of the Cash Flow generated by a company. But, both are calculated on a per share basis.

Earnings Per Share /EPS – And How It Indicates the Company Performance

Company’s periodical profit is commonly distributed over the number of shares outstanding. So earnings per share is the calculation of the portion of profit that an each individual outstanding share gets allocated by the company.

A snap-shot of the annual report of 'Gennex Laboratories Ltd' ffrom 2012 -2016, depicting the portion EPS and CEPS
EPS AND CEPS FOR GENNEX LABORATORIES LTD.

 

Earnings Per Share looks at the Net Income of a Company and is calculated per Share.

The formula used to calculate is as follows.

EPS =  Net Income – Dividends Paid on Preferred Stock / The Number of Outstandingstanding Shares

The calculation will be more accurate, if we use a Weighted Average Number of Shares over the reported period, instead of shares outstanding at the end of the period. This is the most common phenomena of calculation followed by many Data Sources. This may simplify the calculation, but it’s not so accurate method of estimating the profit distribution.

Example

Let’s assume that, a company ABC has a Net Income of Rs. 10 Crores for the financial year 2016. And, the company paid out, Rs. 1 Cr. In the form of Preferred Dividends. If the company’s outstanding shares for the first 6 months was, Rs.100 million for the first 6 months and Rs.110 million for the next half. Then, the EPS is calculated as follows.

Weighted Average Number of Shares Outstanding = 100 (1/2) + 110 (1/2) = (50+55) = 105 M

And, EPS = 90000000/105000000 = 0.85

Significance of Earnings Per Share

  • Earnings per share is the best indicator of any company’s profitability in comparison with other stock valuation methods.
  • It is the major component, while calculating the Price –to-Earnings Ratio (P/E).

An Important Aspect to Remember

If we need to choose between two companies with the same EPS value, it’s good to choose a company with less equity /capital investment. The company is said to be more efficient, as it’s capable of generating the same income with comparatively less capital.

One must not analyze the company performance, by simply looking at a single financial ratio, which may lead to a manipulated calculation. So it’s always a good practice to look at, all the important aspects of a business, including its earnings growth potential and then come up with a single big aspect to decide upon.

Types of EPS

Basic EPS

There are companies with simplified capital structures. These companies don’t possess, any diluted-outstanding shares /securities like preferred shares, convertible debentures, warrants or equity options. While calculating the EPS, the weighted average number of shares is simply the number of shares outstanding over a period of time.

For example, company ABC has 9 million of shares outstanding, paid a preferred dividend of Rs. 1 million from the net profit of Rs. 10 million, then its basic EPS is,

Basic EPS = (10-1) /9 = 1

Diluted EPS

For companies with complex capital structure, it’s preferred to calculate, the diluted EPS.  Then only, we will arrive at the correct number of EPS, that reflects the actual profit distributed over the number of shares and for the period, concerned for calculation.

For example, consider a company ABC, which has 9 million of shares outstanding, similarly as that of the previous company, but also has a convertible preferred shares of 1 million, which can be converted into 3 million common shares. And, if the company paid, preferred dividend of Rs. 1 million from the net profit of Rs. 10 million, for the last quarter. Then it’s diluted EPS is calculated as follows.

Diluted EPS = (Net Profit) – (Preferred Dividend) /(No.of shares outstanding + Number of common shares converted from convertible preferred shares)

Diluted EPS = (10 – 1) /(9+3) =  9 /12 = 0.75

See the difference. That’s what the difference between the basic and diluted EPS actually is.

Cash Earnings Per Share

There are so many other factors that directly or indirectly affect the total cash flow, vis a vis the earnings per share of the company. Hence, the cash earnings per share, takes into account all those extra factors and gives out a different EPS figure.

Factors like, depreciation, amortization of goodwill and such other tangible and intangible factors have their own impact on the company’s present and future performance. Of course affects the cash flow in its usual sense. Hence, it’s always a good practice to consider a ‘Cash earnings per share’ to come out with more accurate numbers called CEPS. This is the number, that indirectly tells about the company’s past performance, vis a vis its future growth rate.

One more important factor that supports the accuracy of Cash EPS is that, the cash flow cannot be manipulated as easily as the net income.

Formula to calculate Cash Earnings Per Share /CEPS

We can calculate the CEPS in three different ways as follows.

Cash EPS = [Cash Flow (Operating)] /[Diluted Outstanding Shares] (or)

Cash EPS = EPS + Amortization of goodwill and other intangible items (or)

Cash EPS =  [Net Income + Depreciation] /Oustanding Shares.

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Thanks for reading this article. Hope, you don’t forget to give your comments duly.

 

 

 

 

 

Hameeda Ghori

Certified Financial Planner And Stock Analyst

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