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If you invest your savings to the purchase of some shares on the stock exchange, then you
probably perform some analysis in order to select the right stock.
Well, this is at least what you should do. Still, your own hard-earned money needs to work
efficiently to make you enough profits for your retirement (or for whatever you want).
In most cases, the investors, whether institutional or individual like you, look to a few measures.
What is it?
The price-earnings ratio tells you how many years of the same earnings you need to wait until
you get the price you paid for the shares back.
When PE is 10, then your investment into certain share will theoretically return back to you in 10
years (if all company’s earnings are paid out as dividends – that’s why it is purely theoretic).
P/E Ratio = Market value per share / Earnings per Share (EPS)
Actually, you can get the numerator, or the market value per share, from the data on the stock
exchange – not a problem.
The earnings per share usually come from the company’s financial statements.
And, in order to make this amount reliable and comparable, we have the standard IAS 33
Earnings per Share giving the guidance about how to present EPS.
In this article, I want to outline the basic rules for EPS calculation and show a few examples.
“OK, that’s fine, but EPS is needed only for stock exchange. Our shares are not publicly traded,
so should we really bother?”
No.
Whose ordinary shares (or potential ordinary shares) are traded in a public market (stock
exchange), or
Whose financial statements are filed or in the process of filing with a securities commission or
similar regulatory body for the purpose of issuing the shares in a public market.
If you present both consolidated and separate financial statements, then you should present EPS
based on the consolidated information.
However, if you also disclose EPS on your separate financial statements, then you present
“separate” EPS only there, not in your consolidated financial statements.
If you have to present earnings per share, then you need to present both:
1. Basic EPS
2. Diluted EPS
In other words, you do not count with any potential ordinary shares and their effects (more about
it a bit later).
Earnings
Earnings basically include all items of income and expense including tax and non-controlling
interests LESS the net profit attributable to preference shareholders, including preference
dividends.
Shares
The weighted average number of ordinary shares during the period is used, but this number
must be adjusted for all events that changed the number of shares during the period.
So, you would be looking at issuance of the new shares for cash, buying back some shares, etc.
Some complications might also arise with the bonus issues or rights issues – here, you don’t
adjust the number of shares in the same way as with issuance for cash or buy back for cash.
Instead, you need to adjust the number of ordinary shares before the event, as if the event
occurred at the beginning of the period.
ABC company had a share capital of 10 000 ordinary shares of CU 1 each and 1 000 redeemable
preference shares of CU 1 each as of 1 January 20X1.
On 1 June 20X1 ABC issued new share capital of 2 000 ordinary shares (CU 1 each) for cash.
In 20X1 ABC’s profit after tax was CU 20 000. ABC paid the preference dividend of CU 0.20
per share during 20X2 and it was included as a finance charge within the net profit.
Solution:
With EPS, always calculate “earnings” and “shares” separately, then connect the dots and come
up with EPS:
Earnings = CU 20 000Here, you don’t adjust earnings, because the question says that the net
profit has already been adjusted for the preference dividend.
Number of shares:This is a little more complicated here, because ABC issued some new capital
for cash during the year.
Let’s set up a table:
*Note 1: Weighted average n. of shares is calculated with the n. of days as weighting factor, e.g.
151/365*10 000 = 4 137
*Note 2: During the exam, you can use months instead of days.
DEF had a share capital of 200 000 shares (CU 1.00 each) at 1 January 20X3. On 31 August
20X3, DEF made a bonus issue of 40 000 shares.
Solution:
The bonus issue simply means the issue of new shares to the existing shareholders without the
corresponding increase in cash.
Therefore, we need to adjust the number of ordinary shares before the event and also, restate the
EPS for previous year:
Calculating EPS is more demanding here, because you need to come up with theoretical ex-
rights price first and then you need to restate the EPS for the previous period and adjust both
earnings and number of shares in the current EPS.
These instruments are called “potential ordinary shares” and they can have two-fold impact on
your EPS:
Earnings: they could be affected by saving some expenses on potential ordinary shares, for
example, when some loan converts to the shares, you stop paying the interest on that loan.
Shares: naturally, when the potential ordinary shares convert to ordinary shares, the number of
shares goes up and it dilutes the EPS.
Before you start calculating the diluted EPS, you need to determine whether the potential
ordinary share is dilutive or not:
Some potential ordinary shares can have dilutive effect (your EPS would go down) and some
can have antidilutive impact (your EPS would go up).
IAS 33 requires ignoring antidilutive shares – you just present the effect of dilutive shares.
Please don’t forget that because this is a very common mistake either during the exams or even
in the real-life financial statements.
When it comes to adjusted number of shares, you always need to assume that all
dilutive potential ordinary shares will convert at the beginning of the period.
In 20X1, KLM had earnings of CU 8 000 and 25 000 ordinary CU 1.00 shares.
On top of that, KLM had issued convertible loan stock of CU 10 000 with interest rate of 8%.
The loan is convertible in 2 years at the rate of 1 ordinary share for every CU 4.00 of a loan
stock.
The tax rate is 20%. Calculate both basic and diluted EPS.
Solution:
The basic EPS is easy: CU 8 000/25 000 shares = CU 0.32 per share.
1. Earnings:
KLM will save 8% interest on convertible loan if the loan is fully converted to ordinary
shares.Pre-tax adjustment is: CU 10 000*8% = 800
2. N. of shares:
KLM would issue 1 share per CU 4.00 of a loan stock; that is CU 10 000/4 = 2 500 the new
sharesAdjusted n. of shares = N. of shares of 25 000+ adjustment of 2 500 = 27 500
3. Diluted EPS = Adjusted earnings/Adjusted n. of shares = 8 640/27 500 = CU 0,314 per
share.Thus the dilution is earnings is CU 0,32 – CU 0,314 = CU 0,006 per share.
Here, never forget to determine whether the potential ordinary shares (in this case, convertible
loan) or dilutive or antidilutive.
In this example, we could have done that very easily – just calculate the incremental EPS and
compare with basic EPS.
The basic EPS was CU 0,32 per share and the incremental EPS is 0,256 which is LOWER than
the basic EPS.
Therefore, the loan stock is dilutive (if it would have been higher, then the loan stock would have
been antidilutive and you would IGNORE it).
It is very easy to do it when you have just one type of potential ordinary shares, but if you have
more than one, you should first determine whether it is dilutive or antidilutive.
Source: ifrsbox.com