For example, if a company has 2 crore outstanding shares and the net profit is Rs 2 crores, then the EPS is Rs 1.
Formula for EPS: Net profits/ Outstanding shares
Significance of EPS
The earnings per share is an important parameter when evaluating if a stock is cheaply valued or expensively valued. However, EPS is considered along with the price to earnings ratio.
The price to earnings ratio is market price divided by the EPS. So, if the current market price of a stock is Rs 35 and the EPS Rs 5, then the price to earnings or P/E ratio is 7.
So, if company A has a P/E of 7 and company B has a P/E is 12, than we generally conclude that company A is available at a more attractive valuation. However, there are various other parameters that are used in arriving at whether a stock is attractive or not.
These would include future growth prospects, price to book value, return on networth etc. Some stocks are accorded higher price to earnings ratio considering the stability of the industry, future prospects etc.
For example, on the Indian bourses the stock of Hindustan Unilever is quoted at a very high price to earnings multiple. The stock is quoted thus because of the fact that it is a multinational and is also a dominant company and its focus on the fast moving consumer goods segment, makes it enviable, as it is a recession proof business.
Along with EPS the diluted EPS also assumes significance. Diluted EPS takes into account any increase in the outstanding shares of the company that are likely or may have happened in the past. However, this could be a rare occurrence as dilution of equity does not happen too often.