What is EPS? How to calculate and apply EPS index effectively

What is EPS? Many investors must be interested in this EPS (Earnings Per Share) index because it has an extremely important and necessary meaning, helping investors to easily calculate the profits earned on each type of stock, thereby calculating the effective profitability of the business. Join Forex to learn more about this index to better understand it.

What is EPS?

EPS stands for Earnings Per Share, which refers to the profit earned per share of stock. This metric represents the post-tax profit that investors can earn from a share they trade. Simply put, the EPS ratio signifies highly favorable and profitable opportunities for investors to make gains.

EPS is also utilized by investors to conduct objective analyses and assessments of a company’s profitability. Based on this, they can make informed decisions about whether to invest in a stock or choose the most effective stock to invest in. EPS is used to allocate earnings to the shares currently outstanding in the market.

Example Illustration:

A company issues 1 million shares that are currently outstanding. The company’s after-tax operating profit for the year 2021 amounts to several million USD. Therefore, 1 million shares would result in an EPS of 2 million USD, or 2 USD in earnings per share.

Classification of EPS

To better understand the EPS financial metric, let’s explore its classification. Currently, EPS is classified into two types: Basic EPS and Diluted EPS. Each classification of this metric has different characteristics, as detailed below:

Basic EPS

Basic EPS is the basic earnings per common share. Basic EPS will often be used in the financial statements of the company or the financial statements of other capital projects.

Basic EPS calculation formula:

Diluted EPS

Diluted EPS is a ratio commonly used by companies to calculate post-tax earnings per share when the company issues additional shares in the market. This includes convertible shares, preferred stock, ESOPs, warrants, and other similar financial instruments.

In calculating diluted earnings per share, the assumption is made that the dilutive securities are issued during the year and would be converted into common stock shares at a later time. The formula for calculating diluted EPS is as follows:

As you can see, Diluted EPS provides more accurate figures than Basic EPS because it directly reflects the changes in the volume of shares in the future. If an investor focuses solely on Basic EPS and disregards Diluted EPS, it can certainly lead to significant errors. Therefore, in order to accurately measure the post-tax earnings of each share, investors should be cautious and take into account both Basic EPS and Diluted EPS for precise calculations.

How to Calculate EPS

EPS is calculated by dividing the company’s post-tax income by the total number of shares outstanding. However, the profit referred to in this calculation does not necessarily have to be net profit; it can also be an expected value for the next financial year.

The formula for calculating the financial metric EPS is as follows:

In which:

• Net income (post-tax profit) refers to the profit generated by the company after subtracting all expenses such as operational costs, taxes, depreciation, interest expenses, and other costs. The formula to calculate net income is:Net Income=(Net Income from Operations+Net Income from Financial Activities+Other Income)−Production Costs−Expenses(Management Expenses+Selling Commissions+Other Commissions)−Corporate Income Tax\text{Net Income} = (\text{Net Income from Operations} + \text{Net Income from Financial Activities} + \text{Other Income}) – \text{Production Costs} – \text{Expenses} (\text{Management Expenses} + \text{Selling Commissions} + \text{Other Commissions}) – \text{Corporate Income Tax}
• Preferred stock dividends are the portion of profits that investors can earn from preferred stocks, which are highly attractive for some investors.
• Weighted average number of shares outstanding: This refers to the number of shares currently outstanding. This quantity is calculated based on the average over the period. However, using daily average data for the number of shares outstanding will yield more precise EPS results.

Note: The number of shares currently issued does not include treasury stock. If the EPS financial ratio is high, it indicates a high profitability potential for the company, while a low EPS suggests lower profitability potential.

Example of EPS Calculation

With the analysis in the example below, you’ll better understand the specific way to calculate the EPS ratio.

What is a Good EPS Value?

A common question is: what is the ideal EPS range? Let’s explore this topic in more detail below.

Professional investors with many years of experience have an objective and flexible way to assess earnings per share based on different times and circumstances. However, if you are a new investor, you can rely on the following calculation.

For example, in a stock exchange where the par value of shares is 10,000 VND, at this time, shares with an EPS > 1,500 VND are considered potential and have a fast growth rate. If you intend to follow this, investors can choose companies with an EPS of at least 1,000 VND or possibly higher.

The relationship between P/E and EPS

P/E and EPS are considered to have a close and interconnected relationship. These two indicators play a crucial role when combined by many investors to assess stocks and make the most suitable and effective trading decisions. In this context, P/E is the indicator that helps you evaluate the relationship between the stock’s value (market price) and the earnings earned per share (EPS).

Formula for calculating the P/E ratio:

P/E = P / EPS

Therefore, EPS is a component of P/E. It can be said that P/E will tell investors how many times the current stock price is higher than the earnings yield per share (EPS), and it also helps determine whether or not to invest in the company’s stock.

Example: If the current stock price is $100 and the earnings per share (EPS) is $10, then the P/E ratio will be 10 times. If the earnings per share (EPS) is $50, then the P/E will double. The lower the P/E ratio, the cheaper the stock price. The higher the P/E ratio, the more expensive the stock. In short, a low P/E is important because it means you are making a large profit due to the stock being cheap.

Significance of the EPS indicator

Every financial indicator has its own unique significance, providing crucial core values that investors need to pay attention to. Below are the key points that investors or businesses should know about the significance of EPS.

The EPS indicator is extremely important for investors, specifically:

EPS helps investors evaluate the effectiveness of business operations at a company.

EPS is an indicator that reflects the efficiency and results of a company’s business operations, and it is commonly used by investors to analyze a company’s profitability.

Additionally, EPS will show the net earnings per share, regardless of the size of the company. The higher the earnings per share, the more attractive it is to investors. Furthermore, you can compare a company’s earnings per share across years to understand its growth rate and profitability.

EPS can help investors easily compare different types of stocks

EPS is also used to compare the business results of companies in the same industry. This helps you easily understand and compare different promotional programs when making decisions on spending. Which stocks should you invest in to achieve the highest profitability? Which ones offer the best business performance for you?

A specific example below will help you better understand this significance: Companies A and B have the same EPS, but Company A has fewer shares, which means Company A is using capital more efficiently than Company B.

Using EPS to calculate other financial indicators

EPS is used to calculate various other financial indicators such as ROE and P/E. Specifically, the formulas for calculating ROE and P/E are as follows: ROE = EPS / Company’s Capital, P/E = P / EPS.

Applications of the EPS indicator

Mastering the application of the EPS indicator will bring meaningful insights and effective applications that you should not overlook. Below are some of the most effective applications that you can learn when exploring the EPS indicator.

Use EPS to predict whether stock prices on the market will tend to increase or decrease in the future.

When you can accurately calculate the EPS index, you can make judgments, predictions and comments on specific trends or fluctuations of this index in the future, thereby evaluating and making decisions about the stocks you are holding or the stocks you plan to buy in the future.

Stock Price = EPS x P/E

Assuming the value of the EPS index increases, there are two specific scenarios for the future stock price trends:

• If the current P/E value is much lower than that of other companies in the same industry, the P/E value of the company will likely increase accordingly in the future. In this case, the stock price may continue to rise in line with the growth of the company.
• If the current P/E value is much higher than the expected level for companies in the same industry, the P/E value of the company may decrease in the future, meaning the stock price of the company will likely continue to decrease as well.

Using EPS to make the best quality assessments of growth value over different periods

To do this, you first need to determine the growth rate of earnings per share (EPS) using the following formula:
EPS Growth Rate (%) = (EPS1 – EPS0) / EPS0. The growth rate represents the rate of increase in earnings. For a company being evaluated, a high index means the company is highly regarded, and conversely, a lower index indicates the company is viewed less favorably.

Determining whether the capital increase is meaningful

To raise more investment capital, companies often raise funds by issuing shares. This leads to an increase in the number of shares, and consequently, the EPS may temporarily increase. After the capital raising period, if EPS continues to rise, it indicates that the company is succeeding in its new business operations, profits are increasing, and the capital is being effectively utilized. On the other hand, if EPS decreases, it suggests that the company is performing poorly, and profits are not increasing significantly.

Calculating the stock exchange ratio in mergers and acquisitions

After companies undergo mergers and acquisitions, companies with different stock prices will naturally become one. In this case, it is necessary to conduct a stock exchange at a reasonable ratio to persuade the shareholders of both companies to join.

An illustrative example: To make Company B a subsidiary of Company A, Company A will need to exchange its shares for shares in Company B. Then, EPS is often used to determine how many shares of Company A each share of Company B represents.

Evaluating whether the company you’re acquiring is good

External evaluation of EPS will be used to make it easier to calculate the stock exchange ratios when acquiring a company. This ratio will also serve as the basis for deciding whether to acquire that company or not.

In addition, the EPS indicator can specifically show potential growth values and drive profits, not just related to sales revenue. If daily revenues increase but the EPS remains unchanged, it suggests that the profitability of the company is not significant. Of course, M&A decisions are not solely driven by EPS, but EPS can be one of the influential factors in making decisions regarding this activity.

Some limitations of the EPS indicator

Although EPS plays an important role and brings high effectiveness, it also has certain limitations when used. Therefore, investors need to pay special attention to how they use it to achieve the most specific and effective results.

• EPS can have a negative value (in the case of negative after-tax profit, when a company is making a loss), and in this case, the P/E ratio loses its economic significance if the denominator is negative. In this situation, you need to use other measures to apply and calculate stock valuation.
• EPS will change based on business fluctuations, such as from selling business assets or businesses in highly cyclical industries. In such cases, you should compare the current EPS with that of recent years. This will allow you to make the most accurate predictions about the current business situation of the company and its future trends.
• Companies issuing convertible bonds, common shares, ESOP shares, or stock splits will reduce earnings per share.
• If you are not cautious, investors who purchase shares based on EPS may miss out on profits. By using the EPS indicator when deciding to buy shares, investors can accept the risks of investing in companies that artificially increase profits by increasing accounts receivable and other inventory types.

So, we’ve explored the EPS indicator in detail. We hope this article on the EPS financial indicator from Forex has helped you better understand this financial metric. Follow us for more useful information about financial trading activities.