A company’s earnings per share (EPS) is a measure of profits a company can allocate to each share of common stock currently outstanding. EPS illustrates the company’s profitability to shareholders. The cash EPS is a measure of operating cash flow against diluted shares outstanding. The diluted EPS assumes the conversion of all convertible securities into its calculations.
Cash EPS Purpose
The purpose of calculating the cash EPS of a company is to evaluate how much cash flow the company generates per share and to assess its ability to service its debts and pay out dividends. Investors and analysts use operating cash flows only in cash EPS calculations and do not include items such as cash flows from investing activities. Investors and analysts use operating cash flows only in cash EPS calculations to see exactly how much cash flow the company generates per share based specifically on its regular business activities.
Cash EPS Calculations
To calculate cash EPS, investors divide operating cash flow by diluted shares outstanding. Operating cash flows are earnings a company makes from its normal business activities or earnings before interest and taxes (EBIT) plus depreciation minus taxes. Diluted shares outstanding include common shares outstanding plus options, warrants, contingent shares and convertible securities.
Diluted EPS Purpose
Investors calculate the diluted EPS to discover the smallest EPS they could potentially receive from a company’s stock. The diluted EPS assumes that all shareholders that currently hold convertible securities, such as options and warrants, have converted their shares to common stock. For example, when a company offers options to its employees, it gives the employee the option to purchase a set number of common shares at a discounted price on a specific date in the future. Technically, the shares are issued, just not converted. The employee converts his options to common shares on the exercise date stated on his options contract.
Diluted EPS Calculations
To calculate the diluted EPS of a company, investors take the number of common shares that resulted from assuming the conversion of all convertible securities and adding this number to the total number of common shares currently outstanding. This gives them the average number of shares outstanding. They then subtract preferred dividends paid out from net income. Investors then divide that number by the average number of shares outstanding to obtain the diluted EPS.
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