Earnings Per Share or EPS is one the most important parameters for fundamental analysis of a stock. Therefore, most investors eagerly look to the EPS to determine, the valuation of a stock, though it has to be studied with other parameters as well.
What Is Basic EPS?
EPS is nothing but the net profits of a company divided by the number of outstanding shares. Let's assume that a company has a profit of Rs 1 crore and the outstanding shares are 10 lakh.
Then the EPS would be arrived as follows:
Basic EPS= Rs 1 crore/10 lakh= Rs 10
Therefore, we can say that the EPS of the company is Rs 10.
What is Fully Diluted EPS?
Diluted EPS will take into account future expansion of any outstanding shares. This will include an increase in outstanding shares due to convertible bonds, stock options or convertible bonds.
Let's say in the above example, the outstanding shares were 10 lakh and then another 1 lakh is expected to be added by way of employee stock option. This would mean that the outstanding shares would be 11 lakhs. So, the fully diluted EPS would be = Rs 1 crore/11 lakh. So, the EPS would be Rs 9.09.
As seen in the above example, the fully diluted EPS would provide the correct picture when doing a fundamental analysis. The basic EPS would not be the right EPS figure to take.
Most companies in India, when they declare their quarterly results provide figures for Basic EPS and fully diluted EPS.
Investors are therefore advised to take note of the fully diluted EPS and then arrive at the price to earnings ratio before investing.
Price to earnings ratio can be got by dividing the current market price of a stock with its EPS. So, if the share price of PNB is Rs 130 and the EPS is Rs 10, we say that the price to earnings multiple is 13.
The PNB stock is then compared with other banking stocks to see the p/e multiple. Other parameters are also used and analysts can then determine, if a stock is undervalued or overvalued.