A BRIEF ON EARNINGS PER SHARE FOR BETTER INVESTMENTS

Earnings Per Share (EPS) simply refers to shareholders’ part in adjusted net profit(Total Earnings) of a company. For calculating EPS, adjusted net profits attributable to shareholders are divided by the outstanding number of shares to find out the earnings.

Net profits attributable to shareholders taken without adjustment gives us the company's ‘Basic EPS’ whereas adjustments in net profit are done to find out ‘Diluted EPS’. These adjustments consider potential conversion of debentures, options, preference shares etc. into equity shares. Obviously these conversions will increase outstanding equity shares in the future consequently the denominator for calculation of EPS will increase and EPS will be lesser. Moreover, the numerator for calculation shall also be adjusted, that is net profit attributable to shareholders but how can we show an increment in net profit due to potential conversion?

The answer is simple, you need to have data for future savings if your debentures, options, preference shares etc. gets converted into equity shares.

For example, long-term convertible borrowings such as 10% Debentures sits in your balance sheet at an expense in the form of interest payable (net of taxes), now if these debentures are converted into equity shares, your expense will be gone which will add to your net profit.That’s why adjustment in net profit is done to give true picture to shareholders of their earnings per share they are holding.

Determining earning per share alone is probably not much of a useful measure. For example two companies who have same earning per share are independent of the hype one has in the market over the other, say HCL Tech has Diluted EPS of around ₹40 meanwhile a tech garage making a net profit of ₹2,00,000 has 4000 equity shares outstanding making diluted EPS of ₹50, here clearly no evidence of HCL being more trustworthy will immediately make me run towards investing my money in a garage company.

Let's put in picture another concept that is P/E Ratio which is market price of shares divided by earning per share. It is one of the most frequently used ratios in trading, business and finance.Why?

Let's go back to our garage (not 'our' garage because we have not invested yet) to see what happens if we compare the P/E ratio of HCL with tech garage.

HCL has market price per share of around ₹1000 and EPS ₹40, so P/E ratio will be calculated by dividing both to consequently get 25 times whereas market price per share is ₹350 for tech garage due to lower market share (or other reasons) and EPS ₹50 which gives P/E ratio of 7 times. Higher P/E ratio indicates better market share and prestige or value of brand in the market. HCL through our ratio speculation appears investable.So, the winner here is HCL. But what happens when the P/E ratio is too much higher? Think twice before investing. Why?

Because stocks having market price higher than expectations are not based on fundamentals of the company rather on blind speculation and greed in the market. Basically,higher market price inflates P/E ratio.

So, your first checklist before investment in any company is now completed.