EPS

Test Your Knowledge

Quiz: Understanding Earnings Per Share (EPS)

Instructions: Choose the best answer for each multiple-choice question.

1. What does EPS stand for? (a) Earnings Per Shareholder (b) Earnings Per Stock (c) Earnings Per Share (d) Equity Per Share

2. The formula for calculating EPS is: (a) Net Profit + Number of Outstanding Shares (b) Net Profit - Number of Outstanding Shares (c) Net Profit / Number of Outstanding Shares (d) Number of Outstanding Shares / Net Profit

3. Which type of EPS reflects past performance based on audited financial data? (a) Forecast EPS (b) Consensus Forecast EPS (c) Historical or Trailing EPS (d) Projected EPS

4. What is a potential limitation of using EPS as a sole investment metric? (a) It always accurately reflects future performance. (b) Different accounting practices can influence the EPS figure. (c) It is not influenced by share buybacks. (d) It is easily understood by all investors regardless of background.

5. What is Consensus Forecast EPS? (a) The EPS of the most successful company in a sector. (b) An average of EPS forecasts from multiple analysts. (c) The EPS predicted by the CEO of a company. (d) The lowest EPS forecast among analysts.

Exercise: Calculating and Interpreting EPS

Scenario:

Imagine you are an investor analyzing two companies, "TechCorp" and "TradCo." Both companies have 100 million outstanding shares.

• TechCorp: Reported a net profit of £20 million in the last financial year. Analysts predict a net profit of £25 million for the next year.
• TradCo: Reported a net profit of £15 million in the last financial year. Analysts predict a net profit of £18 million for the next year.

Task:

1. Calculate the historical EPS for both TechCorp and TradCo.
2. Calculate the forecast EPS for both TechCorp and TradCo for the next year.
3. Based solely on the EPS figures (both historical and forecast), which company appears to be performing better? Explain your reasoning. (Remember that relying only on EPS is not a complete investment strategy).

Techniques

Understanding EPS: A Deeper Dive

This document expands on the core concept of Earnings Per Share (EPS), delving into specific techniques, models, software, best practices, and case studies to provide a comprehensive understanding.

Chapter 1: Techniques for Calculating and Analyzing EPS

This chapter explores various techniques used to calculate and analyze EPS, going beyond the basic formula.

1.1 Beyond the Basic Calculation: The simple formula (Net Profit / Outstanding Shares) is a starting point. We'll examine adjustments needed for:

• Diluted EPS: This accounts for potentially dilutive securities such as stock options and convertible bonds, providing a more conservative view of EPS. The calculation involves adjusting the number of outstanding shares to reflect the potential impact of these securities.
• Basic EPS: This is the straightforward calculation using only the number of outstanding common shares.
• EPS from Continuing Operations: This isolates earnings from the company's ongoing business, excluding one-time items or discontinued operations, for a clearer picture of sustainable profitability.
• Pro Forma EPS: This adjusted EPS figure sometimes includes non-GAAP (Generally Accepted Accounting Principles) measures and excludes certain expenses or items that management deems non-recurring. It's crucial to analyze if the pro forma measure is useful.

1.2 Trend Analysis: Analyzing EPS over time reveals important trends. We'll explore techniques such as:

• Year-over-year (YoY) growth: Comparing EPS from one year to the next highlights growth or decline.
• Quarter-over-quarter (QoQ) growth: Provides a more granular view of short-term performance.
• Growth rate calculations: Determining the average annual growth rate of EPS over a longer period.

1.3 Comparative Analysis: Comparing a company's EPS to its competitors and industry averages provides valuable context and insights into relative performance.

Chapter 2: Models Utilizing EPS

This chapter focuses on financial models that incorporate EPS as a key input.

2.1 Discounted Cash Flow (DCF) Model: EPS is often a key driver of future cash flows, making it crucial for accurate DCF valuations. We'll explore how EPS forecasts feed into DCF models to project future value.

2.2 Dividend Discount Model (DDM): For companies that pay dividends, the DDM uses EPS as an indicator of dividend sustainability and growth potential. We'll examine how EPS influences dividend growth rate assumptions in the DDM.

2.3 Relative Valuation Models: EPS is essential for calculating multiples like the Price-to-Earnings (P/E) ratio, which are used to compare valuations across companies in a similar sector.

Chapter 3: Software and Tools for EPS Analysis

This chapter reviews software and tools that facilitate EPS calculation and analysis.

3.1 Financial Modeling Software: Excel, dedicated financial modeling software (e.g., Bloomberg Terminal, Capital IQ), and accounting software packages offer tools for EPS calculations and analysis. We'll explore their features and capabilities.

3.2 Data Providers: Companies like Bloomberg, Refinitiv, and FactSet provide comprehensive financial data, including historical and forecast EPS figures, enabling comparative analysis and trend identification.

3.3 Stock Screeners: Many online platforms offer stock screeners that allow investors to filter companies based on EPS and other financial metrics, aiding in the identification of investment opportunities.

Chapter 4: Best Practices for Using EPS

This chapter highlights best practices to ensure responsible and effective EPS analysis.

4.1 Context Matters: Never analyze EPS in isolation. Consider macroeconomic factors, industry trends, company-specific news, and accounting methods.

4.2 Diversify Metrics: Don't solely rely on EPS. Use it in conjunction with other financial indicators like revenue growth, debt levels, cash flow, and return on equity (ROE) for a holistic view.

4.3 Understand Accounting Practices: Be aware of potential accounting manipulations and inconsistencies across companies. Scrutinize the footnotes of financial statements.

4.4 Consider Future Outlook: While historical EPS is important, focus on forecast EPS and its underlying assumptions to better assess future potential.

4.5 Evaluate Analyst Forecasts: Multiple analyst estimates offer a more reliable view than any single prediction. However, remember that these are just predictions, not guarantees.

Chapter 5: Case Studies

This chapter explores real-world examples illustrating the application and interpretation of EPS.

5.1 Case Study 1: Company A (High Growth, High P/E): Analyzing a company with consistently increasing EPS but a high P/E ratio to evaluate the balance between growth prospects and valuation risk.

5.2 Case Study 2: Company B (Declining EPS, Low P/E): Examining a company with declining EPS and a low P/E ratio to determine whether the low valuation reflects undervaluation or legitimate concerns.

5.3 Case Study 3: Impact of Share Buybacks: Illustrating how share buybacks impact EPS, highlighting both the potential benefits and the need for caution.

These case studies will showcase how EPS, when used thoughtfully and in conjunction with other financial information, provides valuable insights for making informed investment decisions.