Earnings Per Share

Question 1

Importance of EPS

Answer 1

• widely used in financial analysis
• linked to PE ratio
• EPS has an influence on share price
• Potential performance indicator for senior management

Question 2

EPS formular

Answer 2

(Net profit or loss attributable to ordinary shareholders) / (weighted average number of ordinary shares)

Question 3

Basic EPS

Answer 3

Based on ordinary shares currently in issue

Question 4

Diluted EPS

Answer 4

Based on ordinary shares currently in issue plus ordinary shares

Question 5

Bonus shares

Answer 5

• issued in proportion to current share holdings
• EPS calculation is based on total number of shares after the bonus issue. (EPS for previous year has to be adjusted)

Question 6

Rights issue

Answer 6

• offer made to existing shareholders to subscribe for new shares in proportion to current shareholding at a price below the current market price
• equivalent to an issue of full market price + a bonus issue

Question 7

bonus fraction formula

Answer 7

(FV of share before exercise of rights (cum-rights)) / (Theoretical ex-rights price)

Question 8

TERP formula

Answer 8

(FV of all shares + cash received from exercise of rights) / (no. of shares prior to exercise + no of shares issued)

Question 9

When does diluted EPS take place?

Answer 9

• right holders exercise their entitlement at a future date, the number of shares will increase and may lower (dilute) the EPS

Question 10

Financial instruments that can give rights to ordinary shares at a future date

Answer 10

• convertible debt
• share warrants
• Rights granted under employee share schemes
• contingently issued shares (issued upon complement of a contract)

Question 11

Convertible financial instruments’ impact on EPS

Answer 11

• increase profits due to saving of interest and saving on the preference dividend
• increase in number of ordinary share

Question 12

Disclosure of EPS

Answer 12

• basic and diluted EPS are shown on the face of the income statement
• this should include weighted average number of shares

Question 13

Reconciliation of EPS figures

Answer 13

• no. of shares used in the diluted EPS should be reconciled to the weighted average number of shares in basic EPS
• profit attributable to ordinary shareholders should be reconciled

Question 14

Positive aspects of EPS as a performance measure

Answer 14

• used to estimate future growth in earnings, which has an impact on the future share price and level of dividend distributions.
• can be compared with dividend per share; the difference between them is the amount (per share) that is being reinvested in the business and not being distributed.
• used to calculate the earnings yield for inter-company comparisons.
• used in the calculation of P/E ratio. P/E is used by investors to help them identify the relative riskiness of investments, and investments that are over-valued or under-valued by the stock market.

Question 15

Negative aspects

Answer 15

• based on historical earnings. Decisions may have been made to boost current earnings at the expense of future growth.
• Calculation of the earnings figure is affected by the choice of accounting policies (e.g. depreciation), and any changes in policies. Earnings figure may also be manipulated through creative accounting techniques.
• Earnings may be affected by exceptional items e.g. profits / losses on disposal of non-current assets.
• figure is affected by changes in the number of shares in issue e.g. due to new shares issued; share buy-backs.
• calculated on the basis of after tax figures. Where entities are subject to significantly differing rates of tax because they are based in different countries, the comparison is unrealistic.
• negative aspects highlighted above make inter-company comparisons of EPS difficult.