Impact of Earnings per share on Market Value of an equity share: An Empirical study in Indian Capital Market

Abstract

IntroductionEquity valuation is a central question which the academicians and researchers in the field of capital markets are trying to address through different angles. At the same time, the practitioners in the field of stock trading have been working through different clues.Use of accounting information for equity valuation is a field of research which has seen a lot of activities. As described by Kothari (2001) in the recent past this field made seminal contribution with the publication of Ball and Brown (1968). The literature has grown rapidly with over 1000 publications in leading International academic Accounting and Finance journals in the past three decades.A number of accounting variables have been used to explain equity value and equity return. Book value, profitability in many forms, operating assets, earning, earning per share (EPS), residual value, growth in earnings per share, growth in profitability, growth of the company measured in different ways, dividend per share, growth in dividend per share, real option to grow, real option to abandon are some of the variables used to explain equity valuation.Earning is an important variable affecting the market value of equity share. Company producing and selling goods and services useful to citizens in a society and earning revenue covering its cost of production adds to its reserve and build up the same. Once a successful company starts building up reserves it will also look for expanding its scale of operations and thus increase its earnings. Once a company starts earning attractive sum, the equity share will have more and more demand which will result in increase in market value of the equity.Earnings after interest, depreciation and tax belongs to the equity shareholders. Earnings per share is computed by dividing earnings after interest, the depreciation and tax by total number of out standing shares. Dividend may be distributed out of these earnings; whether it is distributed as dividend to shareholders or not, it belongs to the shareholders. Hence earning per share is a measure which the stock brokers and investors will watch carefully and consider it while deciding the market value of the equity share. In the above discussion, we have considered the effect of increase in earnings per share. The reverse will happen if the EPS falls down.From the above discussion it is clear that EPS affects the market value of equity share. Literature review reveals the same.Review of LiteratureOhlson (1995) discusses the role of earning per share and its role in security valuation. . Ohlson (1995) discusses the role of earning, book value and dividends in equity valuation. Collins (1999) discusses the effect of negative earning on equity valuation. Dechow (1999) studies the effect of residual income and the equity valuation.Collins and Kothari (1989) concentrate on the stock price change associated with a given unexpected earnings change. It is based on cross-sectional inter-temporal data. Collins, Pincus, and Xier (1989) study the role of book value of equity in the equity valuation. Dechow (1999) discuss the role of residual value on equity valuation. Miller and Modigliani (1961) studied the effect of dividend policy and the growth of the company on equity valuation.Dechow (1998) attempts to establish the statistical relationship with equity value, earnings and book value. Collins and Kothari (1989) tries to establish the leading relationship between stock returns, change in EPS and firmsize. Zhang and Chen (2007) discuss to establish relationship between equity value, earnings yield, change in profitability, change in capital investment, change in growth opportunity and change in discount rate. In this article equity value is dependent variable, remaining variables are independent variables.Research at the international level indicates that EPS does impact equity market value. In the Indian context, there is no research to establish the relationship between EPS and equity market value. …

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