Welcome to the World of Earnings Per Share (EPS)!
Hello there! Today, we are diving into one of the most important "report cards" in the financial world: Earnings Per Share (EPS). If you’ve ever wondered how investors decide if a company is "profitable enough" compared to its neighbors, EPS is often the first thing they look at.
Don't worry if financial ratios usually make your head spin. We are going to break this down step-by-step using simple analogies and clear logic. By the end of this guide, you’ll be calculating EPS like a pro! This topic falls under HKAS 33 Earnings per Share.
1. What exactly is EPS?
Imagine you and your friends buy a giant pizza (the company’s profit). EPS tells you exactly how much of that pizza belongs to each individual slice (each ordinary share).
Why do we need it? Comparing the total profit of a massive company like HSBC to a small local bank isn't fair. EPS levels the playing field by showing profit on a per-share basis, making it easier to compare companies of different sizes.
2. The Basic EPS Formula
At its heart, Basic EPS is a simple fraction:
\( \text{Basic EPS} = \frac{\text{Net Profit attributable to Ordinary Shareholders}}{\text{Weighted Average Number of Ordinary Shares (WANOS)}} \)
A. The Numerator: Profit Attributable to Ordinary Shareholders
Not all profit belongs to the ordinary shareholders. We must subtract Preference Dividends first because preference shareholders are like "VIP guests" who get to eat before the ordinary shareholders.
Important Rule:
- If preference shares are non-cumulative, subtract only the dividend declared for the year.
- If preference shares are cumulative, subtract the full year’s dividend whether it was declared or not.
B. The Denominator: WANOS
We don't just use the number of shares at the end of the year. Why? Because if a company issues shares halfway through the year, that money only contributed to profits for six months. We use a time-weighting factor.
Example: If you had 1,000 shares for 12 months, and issued another 1,000 shares on July 1st (6 months left), your WANOS is:
\( (1,000 \times \frac{12}{12}) + (1,000 \times \frac{6}{12}) = 1,500 \text{ shares} \)
Quick Review: The "N.O.W." Checklist
1. Net Profit (Minus preference dividends!)
2. Ordinary Shares only (Ignore preference shares in the denominator!)
3. Weighting (Factor in the timing!)
3. Changes in Share Capital (The Tricky Part!)
Sometimes companies change their share count without getting any new cash. This changes our calculation because we have to play "fair" with the past.
Bonus Issues and Share Splits
A Bonus Issue is when a company gives away free shares to existing owners. A Share Split is like cutting one large slice of pizza into two smaller ones—you have more slices, but the same amount of pizza.
The Golden Rule: Because the company didn't get any new money, we treat these shares as if they always existed. We apply this change retrospectively to the start of the year and even to the previous year's comparative figures.
Rights Issues
A Rights Issue is a mix of two things:
1. Selling shares at a price (New resources).
2. Selling them below market value (A "bonus" element).
To solve this, we need the Bonus Fraction:
\( \text{Bonus Fraction} = \frac{\text{Fair Value (Market Price) per share immediately BEFORE the exercise of rights}}{\text{Theoretical Ex-Rights Price (TERP)}} \)
How to calculate TERP? It's just a weighted average price:
\( \text{TERP} = \frac{(\text{Market Value of shares already held}) + (\text{Cash received from rights issue})}{\text{Total number of shares after rights issue}} \)
Step-by-Step for Rights Issues:
1. Calculate the TERP.
2. Calculate the Bonus Fraction.
3. Multiply the shares held before the issue by the Bonus Fraction and the time-weight.
4. Add the shares held after the issue, weighted by the remaining time.
Key Takeaway: Bonus issues and share splits are like magic—they apply to the whole year and the past. Rights issues are part-magic, part-cash, so we only use the "bonus fraction" for the period before the issue.
4. Introduction to Diluted EPS
Investors want to know the "Worst Case Scenario." What if everyone who could buy shares suddenly did? This is Diluted EPS.
We look at Potential Ordinary Shares, such as:
- Convertible Bonds: Debt that can turn into shares.
- Share Options/Warrants: Rights to buy shares at a fixed price.
The "What-If" Logic:
If a bond converts into shares:
1. Numerator: The company saves the interest expense (net of tax) it used to pay. So, profit goes UP.
2. Denominator: There are more shares in the pool. So, share count goes UP.
Did you know? If the "What-If" scenario actually makes the EPS higher than the basic EPS, we ignore it! We only report it if it "dilutes" (reduces) the earnings. This is called the Anti-dilution rule.
5. Common Mistakes to Avoid
1. Forgetting Tax: When adding back interest for Diluted EPS, always multiply by (1 - Tax Rate). The government takes their cut of the savings too!
2. Timing of Bonus Issues: Don't time-weight a bonus issue from the date it happened. Treat it as if it happened on Day 1 of the year.
3. Preference Dividends: Only subtract them from the numerator. Never include preference shares in the denominator (the share count).
6. Summary Table for Quick Revision
Event: New Issue for Cash
Treatment: Time-weight from the date of issue.
Event: Bonus Issue / Share Split
Treatment: Treat as if it happened at the start of the earliest period reported (Retroactive).
Event: Rights Issue
Treatment: Use a Bonus Fraction (Market Price / TERP) for the period before the issue.
Event: Convertible Debt (Diluted EPS)
Treatment: Add back saved interest (net of tax) to numerator; add new shares to denominator.
Don't worry if this seems tricky at first! EPS is all about following the steps. Practice a few "WANOS" tables, and you'll find the rhythm. You've got this!