Vamsi had some excellent comments on yesterday’s post about rights issue, and I thought I’ll take those questions and create a full post based on them.
Essentially, the question was about the different terms used with respect to the capital structure of a company, and I’m going to write about a few terms that are used frequently while discussing share capital.
The first term is Authorized Share Capital, and this simply means the total number of shares that a company is allowed to issue. This is something that a company decides internally, and they can raise this limit (and they usually do) from time to time as the need arises.
When you read somewhere that a company has an Authorized Share Capital of say 237 million shares (like in the case of Religare Finvest) – there is not much you can make out by just that statement.
That’s because you need to know how many shares has the company actually issued out of its permissible limit of 237 million.
The number of shares it has issued is called Issued Share Capital, and this is the term that’s more important because this shows the number of shares that are currently issued by the company, and is also the number of outstanding shares of the company. In this case, the number of issued shares is 173,322,137, and that’s the number to look for.
A lot of you must be aware of the P/E ratio of a company, and that is calculated by dividing the market price of the share by the earnings per share.
But to calculate the earnings per share you need the total earnings, and the number of outstanding shares or issued shares. This is where the issued share capital is used. I see that Religare Finvest had a net profit of Rs. 1,147.75 million, and since we know that they have 173,322,137 shares – we can arrive at the Earnings Per Share by dividing 1147.75 million by the issued or outstanding shares to get an EPS of Rs. 6.62.
Yesterday I wrote about diluting of earnings and what I meant was if you issue new shares then this profit of Rs. 1,147.75 million will now be divided among those many more shares and the EPS available to each shareholder will be reduced.
The last term for today is Diluted EPS; very often you will see an EPS number, and then another number called Diluted EPS.
Diluted EPS is a term that is used to define EPS adjusted for future dilutions owing to stock options and other conversions like debt converted to equity.
Simply put, when a company issues stock options to its employees – the number of outstanding shares don’t increase immediately, but they will increase as the employees exercise their stock options. The diluted EPS takes this increased base into account and reduces the EPS to that extent.
The EPS may not completely dilute because not all employees may exercise their stock options and not all convertible bond holders may convert their debt to shares, but this calculation does give an idea of how low the EPS can go if everyone did so.
These are some common terms used with respect to the capital structure of a company, and the concepts themselves are quite simple if you don’t get lost in the maze of jargon.