Earnings Per Share

How is the basic EPS calculated?

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.

How is the diluted EPS calculated?

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.

How do we calculate the P/E ratio?

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

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

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.