20 years: Chartered accountant & educator

The earnings per share or EPS is a measure of the company’s financial performance during the period. Saket further explains the Price to Earnings ratio, and how both of them are calculated.

The earnings per share or EPS is a measure of the company’s financial performance during the period. Saket further explains the Price to Earnings ratio, and how both of them are calculated.

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4 mins 58 secs

Overview

The earnings per share or EPS is a measure of the company’s financial performance during the period. It shows how much the investors have earned per ordinary share. There are two variations of EPS, basic and diluted.

Key learning objectives:

Understand how the basic EPS is calculated

Understand how the diluted EPS is calculated

Outline the importance of Price to Earnings (P/E) ratio

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Summary#### How is the basic EPS calculated?

#### How is the diluted EPS calculated?

#### How do we calculate the P/E ratio?

#### What is the importance of Price to Earnings (P/E) ratio?

The basic EPS is equal to the net income available to the ordinary shareholders divided by the weighted average number of ordinary shares outstanding.

**Basic EPS = Net income available to the ordinary shareholders / Weighted average number of ordinary shares**

The basic EPS can be compared with either the previous periods to understand the trend in EPS growth, or it can be compared with other companies.

The diluted EPS takes account of all share options and convertible securities and treats them as if they are converted into ordinary shares; that is, it affects the denominator in the basic EPS calculation. The numerator, which is the net income available to the ordinary shareholders, may or may not be affected. Typically, if a company has convertible securities, the diluted EPS is lower than the basic EPS.

The EPS is the denominator in the commonly used Price to Earnings or P/E ratio in valuation.

**P/E ratio = Market price per share / EPS**

Investors and analysts compare the P/E ratio of one company to the P/E ratio of another company in the same industry, or to the industry average to determine if the shares appear to be undervalued, overvalued or fairly valued compared to its earnings. The companies that grow faster than average, for example, some of the technology companies, also have a high P/E ratio. This shows that investors are willing to pay more now due to the growth expectations in the future.

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Expert### Saket Modi

Saket is a financial trainer and consultant based out of London. He specialises in advanced accounting, financial reporting and financial analysis, particularly with regards to International Financial Reporting Standards (IFRS), International Public Sector Accounting Standards (IPSAS) and Financial instruments.

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