What is EPS in the Stock Market? A Complete Guide for Beginners

As a retail investor, understanding fundamental analysis is essential to make informed investment decisions. One of the many metrics investors use to fundamentally analyse a company is earnings per share (EPS). 

In the stock market, EPS is a useful metric that offers insights into a company's profitability, performance, and investment potential. In this complete guide, we will explore the meaning of EPS, how it is calculated, and the different variants used. Additionally, we will also briefly explore the significance of earnings per share and some of its limitations.

What is EPS in the Stock Market?

EPS, or earnings per share, is a financial metric that indicates how much profit a company has generated for each outstanding equity share. Simply, it shows how much money a shareholder would earn for every share they own if all the company’s profits were evenly distributed.

In the stock market, EPS is widely used by investors, analysts and financial institutions to evaluate how well the company is generating net income relative to its shareholder base. The metric is also used to compare the performance of different companies.  

EPS Formula and Calculation

Now that you are aware of the meaning of EPS, let us look at how it is calculated. The metric can be quickly computed with the help of the following mathematical formula. 

EPS Formula = (Net Income – Preferred Dividends) ÷ Weighted Average Outstanding Shares

Note: Net income refers to the company’s earnings after deducting all expenses, including depreciation, interest and taxes. Preferred dividends refer to the dividends payable to preference shareholders (if any). Weighted average outstanding shares refer to the average number of outstanding shares during a specific period.

As an investor, simply knowing the EPS formula is not sufficient. Instead, you must also know how to use it to determine a company’s earnings per share. Here is a hypothetical example to help you understand how to use it. 

Assume there is a company XYZ Limited. The company’s gross total earnings for the financial year 2024 - 2025 is Rs. 78 crores. The total expenses for the financial year amount to Rs. 28 crores. The company has preference shareholders who are entitled to dividends to the tune of Rs. 5 crores. Finally, the weighted average number of outstanding shares during the financial year 2024 - 2025 is 2 crores. 

Net Income = Rs. 50 crores (Rs. 78 crores - Rs. 28 crores)  

Now, by simply inputting the above variables in the EPS formula, we can quickly compute the earnings per share of XYZ Limited. 

EPS of XYZ Limited = (Rs. 50 crores - Rs. 5 crores) ÷ 2 crores 

EPS of XYZ Limited = (Rs. 45 crores) ÷ 2 crores 

EPS of XYZ Limited = Rs. 22.50 

As you can see, XYZ Limited generates a healthy profit of Rs. 22.50 for every outstanding equity share. 

Types of EPS

EPS in the stock market is categorised into different types, with each one being used for different analytical purposes. Here are the most common types of EPS and their significance.  

• Basic EPS

Basic EPS is the most straightforward and commonly reported metric and is calculated using the above-mentioned EPS formula. This particular type of EPS does not account for the impact of any potential dilution from convertible securities such as stock options, warrants or debentures. 

While it is useful for initial analysis, it may present an overly optimistic picture if the company has issued many convertible securities and instruments since they would not be considered for the calculation. 

The hypothetical scenario we explored in the previous section is a classic example of how basic EPS in the stock market is determined. 

• Diluted EPS

One of the more useful types of EPS in the stock market is diluted earnings per share. Stock options, convertible bonds, debentures and warrants, when converted into equity shares, would increase the total number of outstanding shares and reduce the EPS. By accounting for all possible dilution that could occur if convertible securities were exercised, the metric provides a more conservative and realistic estimate of a company's earnings per share.  

The diluted EPS is especially important for evaluating companies with significant convertible instruments, as it helps investors understand the "worst-case" scenario for earnings per share if all such instruments are exercised. It offers better transparency and is generally more reliable for comparison.

For example, let us assume that XYZ Limited currently has 2 crores outstanding equity shares and an additional 1 crores worth of equity shares from convertible securities. Its net income is Rs. 50 crores, and preferred dividends amount to Rs. 5 crores. The diluted EPS, in this case, would be as follows: 

Diluted EPS of XYZ Limited = Rs. 45 crores ÷ 3 crores

Diluted EPS of XYZ Limited = Rs. 15

• Adjusted EPS

Adjusted EPS is a highly refined version of the metric that removes non-recurring, one-time gains or losses that do not represent the ongoing operations of a company. Some examples of such one-time gains or losses include asset sales, restructuring costs, legal settlements and extraordinary income. The primary goal of adjusted earnings per share is to present a clearer picture of the company’s core earnings by eliminating events unlikely to recur in the future.

For example, let us say that XYZ Limited’s gross earnings for FY25 are Rs. 78 crores. Its expenses for that year were Rs. 28 crores, which includes a one-time legal settlement of Rs. 8 crores. In this case, the net income you should take for the EPS formula would be Rs. 58 crores [Rs. 78 crores - (Rs. 28 crores - Rs. 8 crores)]. The adjusted EPS of XYZ Limited would then be as follows:

Adjusted EPS = Rs. 29 [(Rs. 58 crores) ÷ 2 crores] 

• Forward EPS

The forward earnings per share is one of the more unique types of EPS. The metric is calculated using a projection of a company's expected earnings in a future period, typically for the next fiscal quarter or year. 

Unlike basic or diluted EPS, which are backwards-looking, forward EPS gives investors insights into how much the company is expected to earn on a per-share basis in the future. It is especially useful when calculating valuation metrics like the forward P/E ratio. 

Now, it is important to understand that while forward EPS can help identify growth potential, it is inherently speculative and depends heavily on assumptions and estimates that may or may not materialise.

For example, assume XYZ Limited expects to earn a gross revenue of Rs. 100 crores during the 2025 - 2026 financial year. The expenses and the number of outstanding shares remain the same at Rs. 28 crores and 2 crores, respectively. The company’s forward EPS would be as follows: 

Forward EPS = Rs. 36 [(Rs. 100 crores - Rs. 28 crores) ÷ 2 crores] 

Importance of EPS in the Stock Market

In the stock market, EPS is widely regarded as a highly useful metric. Here is a quick overview of some key reasons why it enjoys so much importance.  

• Indicates Profitability

The net income alone may not provide the whole picture of a company’s profitability. For instance, a company with a high net income may still fall short in terms of profitability if the number of outstanding shares is also high. 

Here is where the earnings per share is a better indicator of a company’s profit potential. The metric provides a more transparent and comprehensive outlook of profitability by accounting for the number of outstanding shares.

A higher earnings-per-share essentially means that the company is generating more revenue per equity share, indicating stronger profitability and more efficient operations. Investors often track EPS trends over time to assess whether a company is improving its financial performance and maximising shareholder value.

• Helps Compare Stocks 

A major reason for the high importance of EPS in fundamental analysis is the metric’s ability to be used as a tool for comparing stocks. Investors often compare the EPS figures of multiple companies within the same sector or industry to determine which of them can generate better profits. 

For instance, let us say that XYZ Limited and ABC Limited are two companies operating in the same field. However, XYZ Limited has a significantly higher EPS compared to ABC Limited. At the outset, XYZ Limited is considered more efficient or better managed. 

• Plays a Key Role in Valuation Metrics 

Apart from being a metric by itself, earnings per share is also used in the calculation of other valuation metrics like the price-to-earnings (P/E) ratio. The formula for calculating the P/E ratio is as follows: 

P/E Ratio = Market Price Per Equity Share ÷ Earnings Per Share  

Without the EPS figure for a company, investors cannot calculate the P/E ratio, which is one of the most important and widely used valuation metrics in fundamental analysis.  

Limitations of EPS

As with any fundamental indicator, the earnings per share is also not foolproof. Now that you have seen the importance of EPS in the stock market, let us look at some of its limitations.

• Possibility of Manipulation

One major drawback of earnings per share is that it can be influenced by accounting choices rather than actual business performance. For instance, companies may use tactics like changing depreciation methods, deferring expenses or recognising revenue early to inflate their net income and, by extension, the EPS. 

Such manipulative tactics can mislead investors into thinking the company is doing better than it truly is. Therefore, if you are planning to use the metric as part of your fundamental analysis exercise, it is important to examine the calculation methodology used by the company to ensure that the metric is free from manipulation.   

• Does Not Provide a Complete Picture 

EPS interpretation does not provide a complete measure of a company’s financial health. Instead, it merely provides you with information on how much profit a company is generating per outstanding equity share. 

For example, the metric does not show how much cash a company generates, how efficiently it operates or how much debt it carries. Therefore, a company with a high EPS might suffer from weak cash flows or excessive liabilities. Basing your decisions purely on the earnings per share alone could lead to misguided investment choices. 

EPS vs. Revenue and Other Metrics

Understanding EPS interpretation becomes easier when you compare it with other financial metrics.

Conclusion

Earnings per share (EPS) is a fundamental metric that helps investors understand a company's profitability per share. Investors often use basic and diluted EPS the most among the different variants.

While EPS can be a valuable tool, it has limitations and should not be the sole factor in making investment decisions. It is advisable to combine EPS with other financial indicators like revenue, EBITDA, and cash flow to get a more complete picture of a company’s health.