Earnings per Share

EPS is used particularly by investors and

analysts to assess the performance of a
company over a period of time , and to compare
the performance of a company with that of other
companies
It is a more reliable measure than profit alone
It is used to calculate the P/E ratio
(Price/Earnings)
Need for a standardised approach  SSAP 3 and
FRS 15

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 FRS 14
Defines Basic Earnings per Share as
 The net profit or loss attributable to ordinary
shares after deducting dividends and other
appropriations in respect of non-equity shares,
divided by the weighted average number of
ordinary shares outstanding in a period.
Earnings
 Basic EPS = No of Issued Ordinary Shares

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 EPS
Numerator
The earnings available to the ordinary
shares are:
Net profit after tax,interest, minority interest,
dividends on other classes of shares and
exceptional & extraordinary items.

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 Example for numerator
Illustration 1 £000
Profit before tax & extraord. items 8000
Less tax 2500
Profit after tax 5500
less extraord. items (net of tax) 500
5000
Dividends Preference 1000
“ Ordinary 1800 2800
Retained profit for year 2700

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 Solution to Illustration 1
The earnings figure for EPS purpose:

Profit after tax & extraord items 5000

less preference dividend 1000
Earnings as per EPS 4000

Note: prior to FRS 3, the EPS was calculated on profits

before Extraordinary items thus open to manipulation

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 The Denominator
The denominator is the weighted average
number of ordinary shares in issue during the
period (not the average value)
It is a time weighted average because new funds
were available to generate profits for only part of
the year

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Issue of shares at market value
during the period
Illustration 2
Garnet plc has 4m shares of 25 pence on 1st
January 20x2.
On 1st October 20x2, 200,000 new ordinary
shares were issued at market value
New resources introduced as a result

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 Solution to Illustration 2
The denominator would be the time-
weighted average of the number of shares
during the year
4,000,000 x 12/12 = 4,000,000
200,000 x 3/12 =50,000
Total shares = 4,050,000

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 Bonus Issue
Bonus issues are created by “capitalising”
reserves. In other words, share capital is
increased and at the same time there is a
corresponding reduction in the value of reserves
No new resources are introduced
Earnings are divided by all ordinary shares in
issue at year end
Previous period’s EPS has to be restated for
comparison

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 Illustration 3
Topaz plc has 3m ordinary shares in issue
at 1st January 20x4. On 1st July 20x4 there
is a 1 for 3 bonus issue. (No new
resources as the result of the issue).
The denominator for this period would be
Shares in issue 3,000,000
Bonus issue 3,000,000/3 1,000,000
Total shares 4,000,000
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 Rights issue
A rights issue involves an offer to existing
shareholders to subscribe for new shares
pro-rata to their existing holding
Issue price lower than market price
Treated as a mixture of :
an issue at full market price
a bonus issue

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 Bonus Issue
To reflect the bonus element , it is necessary to calculate an
adjustment factor based on the “theoretical ex-rights price”
Steps required to calculate BEPS if a rights issue made
during the year
1. Calculate average price of shares after the rights issue and
compare to the share price before the issue to identify bonus
element
2. Calculate the weighted average number of shares for the
current year
3. Calculate the BEPS for current year
4. Previous year BEPS is adjusted for bonus element

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 Illustration 4
Zircon plc has 4m ordinary shares of 25 pence
at the beginning of the period 1st July 20x8.
A rights issue of 1 for 2 shares held is made on
30th September 20x8.
The issue price is £3.40 and the market price
prior to issue is £4.
Profit for the year was £7,500,000
EPS for period ended 30th June 20x8 were
£1.05

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 Illustration 4
Calculate the average price of shares after the issue
(theoretical ex-rights value)
2 shares at fair value 8.00
1 share at discounted price 3.40
3 shs at fair value after rights issue 11.40
Theoretical ex-rights price (11.40/3) 3.80
Bonus element (4 - 3.80) .20

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 Illustration 4 cont’d
Calculate weighted average number of shares

Shares to date of rights issue

4.000.000 held for full year 4,000,000
shares from rights issue 2,000,000
bonus shares
((4,000,000 x 4/3.8) - 4,000,000) 210,526
Weighted average number of shares 6,210,256

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 Illustration 4 cont’d
Calculate BEPS for current year
7,500,000/6,210,256 = £1.21
Adjust the previous year’s BEPS for the bonus
element of the rights issue
BEPS for previous year X adjustment factor
£1.05 X 3.8/4 =£ 0.9975

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 Diluted EPS
What is meant by dilution?
A number of classes of persons may be entitled to
become ordinary shareholders at a future date
If entitlement exercised then ordinary shares will
increase and EPS could be reduced or “diluted”
FRS 14 requires diluted EPS be disclosed
Basis of calculation is to assume that the right had been
exercised in full at the beginning of the period under
review and previous year’s figure is adjusted
correspondingly

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 Illustration 5
Ruby plc has 1m ordinary shares of £1
each and £200,000 10% debenture stock
convertible in 2010 on the basis of 3
ordinary shares for every £2 of stock.
The profit after tax for the accounting
period ended 31st December 2001 is
£105,000
The corporation tax rate is 30%

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 Illustration 5
EPS Earnings No of shs
Post tax profit 105.000
Av no of shares during 1,000,000
the period
BEPS 10.5p

No of shares resulting 300,000

from conversion
Interest on converting 20,000
debentures
Less tax (6,000)
Diluted EPS 9.2p 119,000 1,300,000

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Dilution and Options/Warrants
Where options or warrants exist entitling the
holder to acquire ordinary shares at lower than
fair value (i.e. average market price over the
period) the potential issue of new shares should
be split notionally into shares at fair value and
shares at no value. Since shares at fair value is
not dilutive, the denominator is increased by
shares at no value only.

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 Illustration 6 Share Options
On 1st January 20x1, Amethyst plc have issued
share capital of 8m ordinary shares of 25 pence.
Post tax profits for the period attributable to
ordinary shares are £1m
There are options in existence, issuable in 20x2
at an exercise price of £3 per share,
The average market price per share over the
year 20x1 is £5
Calculate the BEPS and the diluted EPS.

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 Illustration 6
EPS Earnings No of shs
Post tax profits 1,000,000
Ave no of shares 8,000,000
during the year
Basic EPS 12.5p
No of shares under 2,000,000
option
No that would have 2M x 3/5
been issued on fair (1,200,000)
value basis
Diluted EPS 1,000,000 8,800,000

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 Limitations of EPS
Measure of growth but must take care when
making comparisons inter-company
Share value
Accounting policies
Based on historical earnings
Open to manipulation
May lead to strategies for short term
improvement
Should consider more than one ratio

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