In
boardrooms, investor presentations, and financial news columns worldwide,
Earnings Per Share (EPS) occupies a position of near-reverence. Managing
directors cite EPS growth as evidence of success. Analysts build valuation
models on EPS forecasts. On the Dhaka and Chittagong Stock Exchanges, EPS is
one of the most closely watched metrics. Yet the claim that EPS growth is the
BEST external measure of shareholders' wealth maximisation requires critical
examination — the reality is considerably more nuanced, and examination
questions frequently invite this critical analysis.
What Is Earnings Per
Share?
EPS =
(Profit After Tax − Preference Dividends) / Weighted Average Number of Ordinary
Shares. It shows how much of the company's after-tax profit belongs to each
ordinary share. If a company earns Tk. 5,000,000 in PAT and has 2,000,000
ordinary shares, its EPS is Tk. 2.50 per share. Rising EPS — from Tk. 2.50 to
Tk. 3.00 — appears to signal improved performance. EPS is also the basis of the
Price-to-Earnings (P/E) ratio, one of the most widely used equity valuation
tools. BAS 33 (IAS 33) requires listed companies to disclose both BASIC EPS and
DILUTED EPS (which assumes all potential dilutive shares — options,
convertibles — have been issued).
The Genuine Merits of EPS
EPS deserves
its prominence for legitimate reasons. It is simple to calculate from publicly
available data, making it accessible to retail investors. It provides a
standardised, per-share basis for comparing companies of different sizes. It is
used widely by analysts in P/E valuation and earnings forecasting models.
Rising EPS frequently — though not always — correlates with rising share
prices, making it a useful and actionable performance signal in the market.
The Critical Limitations —
Why EPS Is Not Enough
IGNORES COST
OF CAPITAL: EPS completely ignores the cost of equity. A company can increase
EPS by investing in any positive-return project, even one earning far below
shareholders' required return. Shareholders' wealth increases only when returns
EXCEED the cost of equity — EPS measures no such thing. MANIPULATION: Share
buybacks reduce the denominator (number of shares) and mechanically increase
EPS with no underlying improvement in business performance. Accounting policy
choices, one-time asset sales, and restructuring charges can similarly boost
EPS without genuine value creation. SHORT-TERM BIAS: Managers focused on EPS
may cut R&D, training, or long-term investment to protect short-term
earnings — destroying future value while reporting rising current EPS.
RISK-INSENSITIVE: Two companies with identical EPS may have very different risk
profiles. Higher-risk earnings should be valued less — EPS does not capture
this dimension. NO DIRECT LINK TO SHARE PRICE: Market value depends on expected
future free cash flows, the cost of equity, and growth prospects — none of
which EPS directly measures.
Superior Measures of
Shareholder Wealth
Economic
Value Added (EVA) measures profit after charging for the full cost of capital —
both debt and equity — directly answering whether returns exceed requirements.
Sustainable Free Cash Flow Growth measures the cash actually generated and
available to investors — harder to manipulate than accounting earnings. Return
on Invested Capital (ROIC) versus WACC — when ROIC exceeds WACC, the company is
genuinely creating economic profit and shareholder wealth. These value-based
measures are not perfect substitutes for EPS but are essential complements that
give a more complete picture of genuine value creation.
The Balanced View for
Examinations
Examination
questions that ask you to 'critically evaluate EPS as a measure of shareholder
wealth maximisation' are looking for balance. Acknowledge EPS's genuine merits
— simplicity, comparability, widespread market use, basis for P/E valuation.
Then articulate its limitations — ignores cost of equity, open to manipulation,
short-term focus, risk-insensitive, no direct causal link to share price. Then
demonstrate sophistication by introducing alternative value-based measures. A
student who can do all three demonstrates genuine understanding, not just
memorisation.
Foot Notes
EPS: (PAT −
Preference Dividends) / Weighted Average Ordinary Shares — profit attributable
to each ordinary share.
Diluted EPS: EPS calculated assuming all dilutive potential ordinary shares
have been issued — always ≤ basic EPS.
P/E Ratio: Market Price
per Share / EPS — reflects how much investors pay per unit of current earnings.
Share Buyback: Company repurchasing own shares — reduces share count and
mechanically increases EPS without underlying performance improvement.