EPS is not a true measure of a Company's profitability.
Shocked? Allow me to delve deeper.
EPS or simply Profit After Tax (PAT)/Number of outstanding shares provides you with something called 'Earnings Per Share' - simply put EPS.
There is a concept in Finance that goes by the name of Cost of Capital (Kc).
Kc (or WACC) is dependent on the weightage and cost of each component of the Capital Structure - mainly Debt (Kd) and Equity (Ke).
While Kd is linked to the interest rates prevailing in the country, Ke is calculated using a popular model called the Capital Asset Pricing Model (CAPM).
For a mature company, the WACC is roughly in the range of 12-13% in India with a 2/3% sensitivity on either side.
This essentially means that for putting 100 in the business, you have a cost of 13 rupees. This cost does not come anywhere in the P&L.
A business makes money if it generates 'Free Cash Flow' - Cash Flow from Operations less Capex is positive or simply put the Return on Capital Employed (ROCE) is higher than Kc.
Higher the incremental ROCE, there is a better cushion of profitability for the company.
Just to put things into perspective, Reliance has a ROCE of 12%, HUL 116%, Nestle 71%.
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