Earnings per Share (EPS) is a traditional method used for determining corporate
value. Similar words like EPS are: Accounting Earnings and Reported
Earnings, except that EPS is divided by the average number of outstanding
Earnings per Share can be calculated by subtracting the dividends on preferred
stock from net income, and dividing the result by the (weighted average of
the) combination of all outstanding common shares and all common stock equivalents
(see figure on the right).
Fully Diluted EPS
Fully Diluted EPS means that all common stock equivalents (convertible
bonds, preferred stock, warrants, and rights) have been included along with
the common stock.
A poor indicator of actual corporate value
Reported Earnings are a very poor indicator of corporate value.
Six major reasons why EPS fails to reliably measure the economic value
of firms are:
- Alternative accounting methods may be employed. Both required
changes by FASB or IAS and voluntary changes can change EPS, but do not
affect economic value.
- Risk is excluded. Both business risk and financial risk are not
accounted for in annual reports.
- Investment requirements are excluded. Changes in for example
the working capital are not considered in Reported Earnings.
- Dividend policy is not considered. For example dividend decreases
will show increased EPS but are in fact value neutral.
- The time value of money is ignored. No present value calculation
in Reported Earnings.
- The increased role which intangible assets play in our economic
system, that has moved from an industrial economy towards a services and
knowledge oriented economy.
Despite Enronitis, Earnings per Share is still being widely used
in many annual reports.
Book: Steven M.
Bragg - Business Ratios and Formulas : A Comprehensive Guide -
Book: Ciaran Walsh
- Key Management Ratios -
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Compare with EPS: EBIT |
P/E Ratio |
Economic Value Added |
Cash Ratio |
Current Ratio |
Return on Equity |
Fair Value |
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