We note from the above chart that Starbucks Basic EPS has increased substantially over the past 5 years. What does this mean and how does is this useful for investors? In this article, we discuss Basic EPS in detail.
What is Basic EPS?
Basic EPS is a simple profitability calculation to find out the earnings of a company per every common share. Basic Earnings per share (EPS) tells common shareholders how much of the available income is associated with the shares they own.
Basic EPS Formula
Basic EPS Formula in a simple capital structure:
The current year’s preferred dividends are subtracted from net income because EPS refers to earnings available to the common shareholder. Common stock dividends are not subtracted from net income.
Starbucks Basic EPS Example
Let us take the example of Starbucks for Basic EPS.
Basic EPS of 2017
- Net Earnings of Starbucks in 2017 = $2,884.7 million
- Weighted average common shares 2017 = 1,449.5 million
- Basic EPS = $2,884.7/1,449.5 = $1.99
Basic EPS of 2016
- Net Earnings of Starbucks in 2017 = $2,817.7 million
- Weighted average common shares 2017 = 1,471.6 million
- Basic EPS = $2,817.7/1,471.6 = $1.91
source – Starbucks 10K filings
How useful is basic EPS to the investors?
If we talk about the importance of basic EPS, there are many. Let’s have a look at them one by one –
- Basic EPS is one of the best measures of profitability. As a result, every investor looks at basic EPS before they ever decide to invest into the company. And basic EPS gives them a clear idea about what to expect from the company in near future. However, only looking at basic EPS won’t offer them the right insights. They also should look at all the financial statements and find out the ratios from the data points they could gather.
- Basic EPS is pretty easy to prepare. You just need to grab an income statement of the company and the balance sheet. Take the net income from the income statement, deduct the preferred dividend (if any) and then divide the figure by the outstanding equity shares. And you will get a figure to look up to.
- If you have been thinking of investing into any one of the companies, you can look at the EPS of each company and then decide which company provides more value per share. You can simply compare and understand which makes the decision making process easier.
- Basic EPS is also used in relative valuation method. It helps figure out the price-earnings ratio of a comparable company.
- Since basic EPS is the indicator of how much net profit has been earned, if a company has higher basic EPS, it is considered that the net profit of the company is also higher.
Basic EPS – A closer look
When you compare the basic EPS of two companies, you need to look at an important aspect.
- Let’s say you’re looking at Company A and Company B. You found that basic EPS of both of these companies are $5 per share.
- If you conclude that both of these companies are performing similarly, it wouldn’t be the right interpretation.
- Let’s say Company A has 10,000 outstanding shares and the net profit (no preferred dividend given) is $50,000.
- And let’s also say that Company B has 2000 outstanding shares and the net profit (no preferred dividend paid) is $10,000.
- Both of these cases will portray that they have same basic EPS, but are they similar in net profits? No. Company A makes more profit than Company B. Since Company B has less outstanding shares, it seems that it has been doing quite well.
While looking at a company and its basic EPS, you should look into the net profit and the outstanding equity shares separately.
Limitations of Basic EPS
Basic EPS is a great measure of profitability. There’s no doubt about it. But one thing you should know that basic EPS alone can’t depict a great deal about a company’s financial health.
Yes, it can talk about how much net profit a company has been earning, whether a company has been generating higher profits, and also whether one company is doing better than another company in terms of earnings per share.
But since the company has been preparing the income statement and the balance sheet, there’s a chance that the company have manipulated the data to showcase a good reputation to its potential investors.
That’s why you should look at P/E Ratio (Price/Earnings Ratio) also along with basic EPS. Plus, you should also look at other financial ratios like Return on Total Assets, Return on Total Capital Employed, Diluted EPS, and the statement like cash flow statement and fund flow statement.
Here we have discussed about What is Basic EPS, its formula, its usefulness to investors along with practical examples. You may also have a look at these articles below to enhance your understanding about Profitability
- Fund Flow Statement Examples & Format
- Outstanding Shares | Formula | Definition
- Earnings Per Share
- What are Contingent Shares?
- Profit Margin | Gross | Operating | Net
- Dividend Payout Examples