Investors use many different types of indexes when analyzing and evaluating a business. In which, EPS plays an important role because it provides a measure of the profit received per share that the investor holds. So what is EPS? How to calculate it? Please join Unich Analysis to learn more about EPS in the article below.
What is the EPS index?
EPS is a financial index that shows the profit received per share over a certain period of time. This index is often used by investors to evaluate the profitability of a company, as a basis for making decisions to buy/sell shares.
EPS calculation formula
You can find the EPS index on stock information aggregator sites or in the quarterly and annual financial reports of some businesses. The simple formula for calculating EPS is as follows:
EPS = (Profit after tax – Preferred dividends) / Number of outstanding shares
However, the accuracy of EPS calculated using this formula can be affected by fluctuations in the number of outstanding shares and dilution of shares. Therefore, there are two other extended formulas used instead, including basic EPS and diluted EPS. Specifically as follows:
Basic EPS
Basic EPS = (Profit after tax – Preferred dividends) / Weighted average number of outstanding shares during the period
In which:
- Profit after tax is the profit earned after deducting all expenses and corporate income tax.
- Preferred dividends are dividends paid to preferred shareholders before calculating earnings per common share.
- The number of outstanding shares is the total number of shares of the company that are currently circulating on the stock market.
Diluted EPS
Diluted shares may come from reasons such as issuing new shares, issuing bonus shares, converting bonds into shares, etc. This leads to a decrease or dilution of the profit for each share that shareholders own.
The number of additional shares does not appear in the simple EPS calculation formula, so the EPS result is higher than the actual one. To limit this, you should use the diluted EPS calculation formula as follows:
Diluted EPS = (Profit after tax – Preferred dividends) / (Weighted average number of shares outstanding during the period + number of shares to be increased)
How much EPS is good? Is high or low EPS good?
Normally, investors in the stock market highly appreciate companies with EPS above 1000. However, depending on the field of operation and the nature of the business, the EPS level considered good ranges from 1000 to 1500.
A good business needs to maintain an EPS level above 1000 for many consecutive years. In addition, you can compare the EPS of businesses in the same industry, combined with other financial indicators to find a good EPS level for each business field.
Meaning and uses of EPS index
In terms of meaning, the EPS index can reflect the business performance of the enterprise and is the basis for comparing businesses with each other, supporting investors in choosing stocks. In addition, EPS is also data to calculate a number of other important financial indicators such as P/E and ROE.
Based on the meaning, EPS is often used to measure profits and predict the future, evaluate management efficiency, and support stock selection. Specifically as follows:
Measure profits and predict the future
Looking at the results of calculating EPS, you can evaluate the profitability of the business. Not only that, combining EPS at different stages can help you evaluate the growth rate of earnings per share, based on the following formula:
EPS growth rate = (EPS1 – EPS0) / EPS0
In which:
- EPS0 is the EPS index of the base stage, before the EPS1 stage
- EPS1 is the EPS index of the following stage.
This ratio gives a specific number to help you measure the EPS growth of a business over a long period. This ratio is positive, meaning that the company has growth over time, this ratio is negative, meaning that the company is operating inefficiently, and profits are decreasing.
The higher the EPS growth rate, the better; businesses with a high rate often receive more attention from investors. In addition, this rate of continuous growth over a long period of time shows that the business has good potential for future development.
Evaluate management efficiency
The EPS index also reflects the management efficiency of the business in a certain period. Accordingly, high EPS means good management efficiency and low or negative EPS means poor management efficiency.
Selecting stocks
Earnings per share are an important factor in showing the value of that stock. Therefore, comparing the EPS of different stock codes helps you compare the value of the companies issuing them. Stock codes with high EPS are often more interested by investors because they have higher profitability, bringing more profits to shareholders.
However, you should not rely solely on EPS when choosing stocks, combine it with other indicators such as ROA, P/E, P/B, Beta, etc. to make a more accurate assessment.
Notes when using EPS
EPS is commonly used when evaluating the stock market and choosing stocks because it is easy to calculate, gives relatively accurate results, and is easy to compare businesses in the same industry. However, this indicator still has some limitations, so when using it, you should note the following:
- When cumulative profits are negative, using EPS to calculate P/E is no longer meaningful. In this case, you can use the P/B index instead of P/E.
- EPS only reflects profits per share, not fully reflecting the quality of the business’s profits. You should combine it with other financial indicators such as ROA, ROE, P/B, etc. to evaluate the financial situation and potential of the business before making an investment decision.
- This index is easily distorted and less accurate when the business is going through a period of volatility such as an economic recession, the company has to sell assets, issue more shares, etc. You should use the extended EPS calculation formulas to get more accurate results.
- Businesses in the same industry may operate in different cycles, which affects the EPS results. Therefore, you should consider the time factor and business cycle to get more accurate results.
- You need to consider the reduction of the company’s capital when calculating EPS because then the EPS index will increase but that does not mean that profits will increase accordingly. The company’s capital reduction can be due to buying back shares, reducing the number of outstanding shares, etc.
Conclusion
Above are the contents related to the definition, calculation method, meaning, uses, and notes when using EPS. This is an important index, easy to apply, and gives relatively accurate results when analyzing the financial situation and profitability of a business’s shares, which will support you well in choosing stocks. Unich Analysis hopes that this information can help you understand and apply EPS well, choosing good stocks for your investment portfolio.
