Investors often rely on headline numbers to make quick, back-of-the-envelope calculations about a company’s growth rates. Such a narrow analysis of changes in revenue, expenses and profits could be misleading if seen in a context bereft of changes in the share capital that was used to generate such earnings. This makes earnings per share (EPS) more useful than the profit-after-tax (PAT) entry because it takes into account the number of shares and therefore provides an effective and easy-to-use metric for making comparisons. It is calculated by taking the total comprehensive income and dividing it by the number of shares outstanding. This figure is also referred to as the ‘basic’ EPS.

Diluted EPS is another variant, which is calculated by dividing the total comprehensive income by the number of shares which would be outstanding if all convertible securities (stock options, warrants, convertible preference shares and debentures) are converted to shares. This makes the diluted EPS a more conservative tool to assess earnings.

But do remember that since the EPS is based on the accrual principles of accounting, it is dependent on management’s estimates. It is worthwhile to see the cash flows from operations along with the EPS to ascertain the amount of cash actually coming in.

CASE IN POINT

Tata Steel BSL For FY21 Tata Steel BSL reported a total comprehensive income of `2,518 crores and has 109.34 crore shares outstanding resulting in an EPS of `23.03. But due to the presence of `12,000 crore worth convertible preference shares, the diluted EPS is only `6.57.

Source: Wealth Insight July'2021