14.3 Earnings per share

Question 1

What is meant by “earnings per share” and how is it calculated?

Answer 1

The residual profits attributable to each equity shareholder.

EPS = [profit after tax, interest and pref. dividends] / average outstanding shares

Question 2

Is it better to have a higher or lower earnings per share?

Answer 2

Higher, as this indicates good health of the company due to large profits per share.

Question 3

What is meant by “basic EPS” (earnings per share)?

Answer 3

Residual profits for a period attributable to the shares outstanding for that same period.

Question 4

What is meant by “diluted EPS” (earnings per share)?

Answer 4

Residual profit for a period attributable to the outstanding shares, adjusted for the effect of dilution (i.e. it is assumed that all convertible securities will be exercised).

Question 5

How is “diluted EPS” (earnings per share) calculated?

Answer 5

Diluted EPS = profit after interest, tax and preference dividends / [average outstanding shares + diluted shares]

Question 6

What are the limitations of earnings per share (EPS)?

Answer 6

• does not represent the ACTUAL income of the shareholder - only what COULD be paid as a dividend
• companies can make EPS look better than it actually is by buying back shares (and therefore increasing EPS)
• ## EPS does not consider debt