Earnings, EPS and DPS (NISM Series XV, chapter 3)

Earnings, and which earnings

Earnings are profits, but a business has several profit lines and each answers a different question.

Net profit

The profit available to the equity owners after everyone else, including lenders and the tax authorities, has been paid.

EBIT

Earnings before interest and taxes: the pool to be apportioned among lenders (as interest), the government (as tax) and owners (what remains).

EBITDA

Earnings before interest, tax, depreciation and amortisation: the earning available to the business first to recover the capital it has invested in tangible and intangible assets, and only then to be shared among lenders, government and owners.

Chapter 8 dissects these lines. Here the point is that the word earnings needs a qualifier, and so does its time frame.

Historical earnings

Profits of previous years.

Trailing earnings

Profits of the most recent period running up to the present, calculated on a rolling basis. The two common variants are trailing twelve months (TTM), the twelve months ending in the current month, and trailing four quarters, the four quarters ending in the current one. These matter when an analyst values a firm at a date that is not a financial year end.

Forward earnings

Profits computed from projections of future revenue and cost.

Net profit belongs to the shareholders, and EPS tells each of them how much of it their share earned.

Formula · Earnings per share

EPS = Net profit / Number of shares outstanding

Strictly, the denominator is the weighted average number of shares outstanding, weighted by the time each share was outstanding during the year.
Net profit of 10 lakh over 2 lakh shares gives EPS of 5 rupees.

A higher EPS shows higher profitability and better earnings for shareholders, so such shares are preferred to those of companies with lower EPS. EPS is a significant variable in determining a share's price, which is why the price-to-earnings ratio, next topic, is built on it.

Exam trapWeighted, not year-end

If a company issues shares halfway through the year, the year-end share count overstates what was outstanding on average. The precise EPS uses the time-weighted average. A question that gives a mid-year issue and asks for EPS is testing whether you weight.

Worked exampleA weighted denominator

A company starts the year with 8 lakh shares and issues 4 lakh more at the start of the fourth quarter. Weighted average shares are 8 lakh for the full year plus 4 lakh for one quarter: 8 + 4 times 0.25 = 9 lakh. With net profit of 18 lakh, EPS is 18 / 9 = 2 rupees, not 18 / 12 = 1.5.

A dividend is the portion of profit the company distributes to shareholders. It is generally declared as a percentage of face value, and that percentage converts to rupees per share: a 40% dividend on a share of face value 10 is 4 rupees. DPS can also be computed directly as the total dividend paid divided by the number of shares outstanding on the record date.

Formula · Dividend payout ratio

Payout ratio = DPS / EPS

The fraction of each rupee of profit that is paid out rather than retained.
EPS 12 and DPS 5 give a payout of 5 / 12, about 41.7%. The remaining 58.3% is retained in the business.

Take these into the exam

Net profit belongs to equity owners; EBIT is shared among lenders, government and owners; EBITDA is what the business has to recover its investment in tangible and intangible assets before that sharing.
Historical earnings are past years; trailing earnings cover the most recent period up to now on a rolling basis (TTM, trailing four quarters); forward earnings come from projections.
EPS equals net profit divided by shares outstanding, precisely the time-weighted average. Higher EPS means more profit per share and feeds the share price.
DPS is the dividend per share, usually declared as a percentage of face value or computed as dividend paid over shares on the record date. Payout ratio equals DPS divided by EPS.