Earnings per Share

Earnings per shareEarnings per share

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Earnings per ShareEarnings per Share

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

FRS 14FRS 14

Defines Basic Earnings per Share asDefines Basic Earnings per Share as The net profit or loss attributable to ordinary The net profit or loss attributable to ordinary

shares after deducting dividends and other shares after deducting dividends and other appropriations in respect of non-equity shares, appropriations in respect of non-equity shares, divided by the weighted average number of divided by the weighted average number of ordinary shares outstanding in a period.ordinary shares outstanding in a period.

Earnings Earnings Basic EPS = No of Issued Ordinary SharesBasic EPS = No of Issued Ordinary Shares

EPSEPS

NumeratorNumeratorThe earnings available to the ordinary The earnings available to the ordinary

shares are:shares are:Net profit after tax,interest, minority interest, Net profit after tax,interest, minority interest,

dividends on other classes of shares and dividends on other classes of shares and exceptional & extraordinary items.exceptional & extraordinary items.

Example for numeratorExample for numerator

Illustration 1Illustration 1 £000£000

Profit before tax & extraord. itemsProfit before tax & extraord. items 80008000

Less taxLess tax 25002500

Profit after taxProfit after tax 55005500

less extraord. items (net of tax)less extraord. items (net of tax) 500500

50005000

Dividends PreferenceDividends Preference 10001000

““ OrdinaryOrdinary 18001800 28002800

Retained profit for yearRetained profit for year 27002700

Solution to Illustration 1Solution to Illustration 1

The earnings figure for EPS purpose:The earnings figure for EPS purpose:

Profit after tax & extraord itemsProfit after tax & extraord items 50005000

less preference dividendless preference dividend 10001000

Earnings as per EPSEarnings as per EPS 40004000

Note: prior to FRS 3, the EPS was calculated on profits Note: prior to FRS 3, the EPS was calculated on profits before Extraordinary items thus open to manipulationbefore Extraordinary items thus open to manipulation

The DenominatorThe Denominator

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

Issue of shares at market value Issue of shares at market value during the periodduring the period

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

Solution to Illustration 2Solution to Illustration 2

The denominator would be the time-The denominator would be the time-weighted average of the number of shares weighted average of the number of shares during the yearduring the year

4,000,000 x 12/12 = 4,000,0004,000,000 x 12/12 = 4,000,000

200,000 x 3/12 =50,000200,000 x 3/12 =50,000

Total sharesTotal shares = 4,050,000= 4,050,000

Bonus IssueBonus Issue

Bonus issues are created by “capitalising” Bonus issues are created by “capitalising” reserves. In other words, share capital is reserves. In other words, share capital is increased and at the same time there is a increased and at the same time there is a corresponding reduction in the value of reservescorresponding reduction in the value of reservesNo new resources are introducedNo new resources are introducedEarnings are divided by all ordinary shares in Earnings are divided by all ordinary shares in issue at year endissue at year endPrevious period’s EPS has to be restated for Previous period’s EPS has to be restated for comparisoncomparison

Illustration 3Illustration 3

Topaz plc has 3m ordinary shares in issue at 1Topaz plc has 3m ordinary shares in issue at 1stst January 20x4. On 1January 20x4. On 1stst July 20x4 there is a 1 for 3 July 20x4 there is a 1 for 3 bonus issue. (No new resources as the result of bonus issue. (No new resources as the result of the issue).the issue).

The denominator for this period would beThe denominator for this period would be

Shares in issueShares in issue 3,000,0003,000,000

Bonus issue 3,000,000/3Bonus issue 3,000,000/3 1,000,0001,000,000

Total sharesTotal shares 4,000,0004,000,000

Rights issueRights issue

A rights issue involves an offer to existing A rights issue involves an offer to existing shareholders to subscribe for new shares shareholders to subscribe for new shares pro-rata to their existing holdingpro-rata to their existing holding

Issue price lower than market priceIssue price lower than market price

Treated as a mixture of :Treated as a mixture of :

an issue at full market pricean issue at full market price

a bonus issuea bonus issue

Bonus IssueBonus Issue

To reflect the bonus element , it is necessary to calculate To reflect the bonus element , it is necessary to calculate an adjustment factor based on the “theoretical ex-rights an adjustment factor based on the “theoretical ex-rights price”price”Steps required to calculate BEPS if a rights issue Steps required to calculate BEPS if a rights issue made during the yearmade during the year1. Calculate average price of shares after the rights 1. Calculate average price of shares after the rights issue and compare to the share price before the issue to issue and compare to the share price before the issue to identify bonus elementidentify bonus element2. Calculate the weighted average number of shares for 2. Calculate the weighted average number of shares for the current yearthe current year3. Calculate the BEPS for current year3. Calculate the BEPS for current year4. Previous year BEPS is adjusted for bonus element4. Previous year BEPS is adjusted for bonus element


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


Calculate the average price of shares after the issue Calculate the average price of shares after the issue (theoretical ex-rights value) (theoretical ex-rights value)

2 shares at fair value 2 shares at fair value 8.008.00

1 share at discounted price1 share at discounted price 3.403.40

3 shs at fair value after rights issue 3 shs at fair value after rights issue 11.4011.40

Theoretical ex-rights price (11.40/3)Theoretical ex-rights price (11.40/3) 3.803.80

Bonus element (4 - 3.80)Bonus element (4 - 3.80) .20 .20

Illustration 4 cont’dIllustration 4 cont’d

Calculate weighted average number of sharesCalculate weighted average number of shares

Shares to date of rights issueShares to date of rights issue

4.000.000 held for full year4.000.000 held for full year 4,000,0004,000,000

shares from rights issueshares from rights issue 2,000,0002,000,000

bonus sharesbonus shares

((4,000,000 x 4/3.8) - 4,000,000)((4,000,000 x 4/3.8) - 4,000,000) 210,526210,526

Weighted average number of sharesWeighted average number of shares 6,210,2566,210,256

Illustration 4 cont’dIllustration 4 cont’d

Calculate BEPS for current yearCalculate BEPS for current year

7,500,000/6,210,256 = £1.217,500,000/6,210,256 = £1.21

Adjust the previous year’s BEPS for the bonus Adjust the previous year’s BEPS for the bonus element of the rights issueelement of the rights issue

BEPS for previous year X adjustment factor BEPS for previous year X adjustment factor

£1.05 X 3.8/4 =£ 0.9975£1.05 X 3.8/4 =£ 0.9975

Diluted EPSDiluted EPS

What is meant by dilution?What is meant by dilution?

A number of classes of persons may be entitled to A number of classes of persons may be entitled to become ordinary shareholders at a future datebecome ordinary shareholders at a future date

If entitlement exercised then ordinary shares will If entitlement exercised then ordinary shares will increase and EPS could be reduced or “diluted”increase and EPS could be reduced or “diluted”

FRS 14 requires diluted EPS be disclosed FRS 14 requires diluted EPS be disclosed

Basis of calculation is to assume that the right had been Basis of calculation is to assume that the right had been exercised in full at the beginning of the period under exercised in full at the beginning of the period under review and previous year’s figure is adjusted review and previous year’s figure is adjusted correspondinglycorrespondingly


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


EPS Earnings No of shsPost tax profit 105.000

Av no of shares duringthe period

1,000,000

BEPS 10.5p

No of shares resultingfrom conversion

300,000

Interest on convertingdebentures

20,000

Less tax (6,000)

Diluted EPS 9.2p 119,000 1,300,000

Dilution and Options/WarrantsDilution and Options/Warrants

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

Illustration 6 Share OptionsIllustration 6 Share Options

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


EPS Earnings No of shs

Post tax profits 1,000,000

Ave no of sharesduring the year

8,000,000

Basic EPS 12.5p

No of shares underoption

2,000,000

No that would havebeen issued on fairvalue basis

2M x 3/5(1,200,000)

Diluted EPS 1,000,000 8,800,000

Limitations of EPSLimitations of EPS

Measure of growth but must take care when Measure of growth but must take care when making comparisons inter-companymaking comparisons inter-companyShare valueShare valueAccounting policiesAccounting policiesBased on historical earningsBased on historical earningsOpen to manipulationOpen to manipulationMay lead to strategies for short term May lead to strategies for short term improvementimprovementShould consider more than one ratioShould consider more than one ratio

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Earnings per Share