Earnings per Share

What are the three ways to measure return to shareholders? (per share)

• Dividend per share

  • uncontroversial and easy to calculate

  • no need for an accounting standard#

• Cash flow per share

  • not much used or understood in Europe

  • no standard yet

• Earnings per share

  • the standard measure

  • the profit each ordinary share earns (in cents)

What is the importance of EPS?

• Largest (or most powerful) group of users of financial statements - stock market analysts & institutional investors

  • They (sadly) don’t have time to read financial reports

• Need indication of return

  • To compare companies and decide on prices

  • Focus on the “Bottom Line” - profit after tax

  • Since they buy shares, they want profit expressed on a per share basis.

• Company profits or earnings per share is not directly comparable

• P/E ratio

  • Dividing the share price by the earnings per share

  • Allow for a “same size”/“common size” analysis

What is the P/E ratio?

• indicates stock market sentiment towards a share.

  • represenst the multiple/number of times future earnings investors are willing to pay for the company now/today.

P/E Ratio Formula

What are the Problems with EPS?

• Abuses by reporting entities

  • Numerator (earnings)

    • Excluding “exceptional” profits and losses (pre-SSAP), treating gains and losses as reserve movements

    • Excluding “extraordinary” profits and losses (pre FRS 3) from the earnings per share calculation

  • Denominator (number of shares)

    • Hiding potential “dilution” of EPS by not accounting for share options

    • Using unclear bases to calculate shares in issue

• Abuses by analysts and brokers

  • Calculating a “house” EPS

  • Recalculating EPS on different bases to suit their

    recommendation

• Generally

  • No clear basis for EPS

    • unreliable and non-comparable figures

  • some companies use year-end share number, while others use averages to calculate EPS

Who calculates EPS?

The entity itself

What profit is it based on?

EPS is calculated based on the earnings available to ordinary shareholders ONLY

EPS Formula