 Personal Finance Powerpoint Presentation, earnings per share EPS. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia, earnings per share EPS, which you can find online. Take a look at the references, resources, continue your research from there. This by Jason Fernando, updated June 19th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investments, that being the fixed income, typically bonds, the equities, typically the common stocks. We're focused on the equity side of things here, thinking about analysis related to the common stock, holding quick recap on what stocks are. Remember corporations, separate legal entity. Stocks represent equal units of ownership in that entity. Most of the times we're talking about stocks that are publicly traded, meaning the company is a publicly traded company, traded on an exchange. Keeping that in mind, we're now looking at, what is earnings per share EPS? Earnings per share is calculated as a company's profit divided by the outstanding shares of its common stock. So we're trying to give an analysis of the earnings per unit of ownership chunks per unit of the common stocks that are out there. The resulting number serves as an indicator of a company's profitability, which is of course what we are trying to determine because the profitability of the company, how well they're doing at making earnings on a per share basis is one factor that we can use to try to value the company and therefore get an idea of what we think the price of the stock should be. It is common for a company to report earnings per share that is adjusted for extraordinary items and potential share dilution. We'll talk possibly more about those in following presentation. The higher a company's EPS earnings per share, the more profitable it is considered to be. So when we're looking at the number, the higher the number, the better the number with the earnings per share. Formula and calculations for EPS earnings per share, earnings per share value is calculated as net income, also known as profits or earnings divided by available shares. Now note when you're thinking about the net income, you're talking about the bottom line income when they say also known as profits or earnings, when you hear the term earnings, you might kind of think of like revenue for example, you gotta make sure that you're picking up the bottom line basically of the income statement assets minus the liabilities divided by the available shares which are those, the number of unit items that are out there representing ownership in the company. So a more refined calculation, adjust the number, the numerator and denominator for shares that could be created through options, convertible debt or warrants. We might dive into that in more detail in future presentations, but note that you could have options that have the capacity to be converted for example, these kind of instruments that could be converted and if they were converted, then you could have a different number of shares that would be out there. So you could kind of factor in the potential of those being converted when doing the calculation of the earnings per share. The number of the equation is also more relevant if it is adjusted for continued operations. So we've got the earnings per share equals the net income minus the preferred dividends. The preferred dividends, some companies might not have preferred dividends but if they do have the preferred dividends, remember that they get paid first. They have the first claim to the earnings. So you got to take those out when you're thinking about the common stock which is typically the stock that we're thinking of with regards to the normal kind of ownership. That's the normal kind of stock we would be considering dividing by end of period common shares outstanding, the amount of shares that are out there that could be owned. Remember that shares do not represent particular owners because one owner could own multiple shares but shares are the units that should be all equal in nature that represent total ownership of the company in essence. So to calculate a company's EPS, the balance sheet and income statement are used to find the period and number of common shares. So you can find the common shares that are there. They might be listed on, say the balance sheet, for example, in the equity section, assets minus liabilities is equity. So divided dividends paid on a preferred stock, if any, so if they have any preferred stock then you got to take into consideration the dividends on the preferred stock and the net income or earnings. The net income or earnings will of course be on the income statement generally. So it is more accurate to use a weighted average number of common shares over the reporting period because the number of shares can change over time. In other words, it could be possible that you're looking at say a timeframe and there was no change or no new issuance or repurchase, for example, of common stock because once they've done the initial IPO, things might be kind of static in terms of how many shares are out there after that. And the trading that happens of shares are usually not coming from the owner or the issuance of the company at that point, but trading amongst investors. But if there have been new shares or change in shares in that timeframe then you might use like an averaging kind of method over the timeframe. So, and remember that's kind of because like on the income statement, the income represents the income statement when we're looking at the net income represents a timeframe, it has to have a beginning and an end like January through December. Whereas when you're looking at the number of shares that are outstanding, that's typically as of a point in time. How many number of shares are out there as of this point in time? So you've got these two different kind of timeframes you're kind of comparing here. And so if the number of shares have changed over that time you might try to use some kind of average. So any stock dividends or splits that occur must be reflected in the calculation of the weighted average number of shares outstanding. Some data sources simplify the calculation by using the number of shares outstanding at the end of a period. So the easiest thing to do would be looking at the shares outstanding at the end as of that point in time. So annual earnings per share. So here's like a calculation or a graph showing the annual earnings per share, annual diluted earnings per share for Apple, Amazon, Facebook, Netflix, Google, Tesla, Ford, Microsoft, and Bank of America. So example of earnings per share, say that the calculation of earnings per share for three companies at the end of the fiscal year was as follows. So we've got the companies, Ford, Bank of America, NVIDA, the net income 7.6 billion. We've got 18.23 billion, 1.67 billion. Preferred dividends, zero for Ford, 1.61 billion, Bank of America, and zero for NVIDA, NVIDA weighted common shares. We got the 3.98, the 10.2, the 0.541 billion. So the basic earnings per share then calculation will simply be the net income on the income statement in essence divided by the weighted common shares which is the 3.98, which you can imagine kind of the shares that are outstanding. Therefore the 1.91, here we've got the 18.23 which is the net income divided by the shares giving us the 1.63 and so on and so forth. So how is earnings per share used? Earnings per share is one of the most important metrics employed when determining a firm's profitability on an absolute basis. It is also a major component of calculating the price to earnings ratio where the E in the PE refers to the earnings per share. So in other words, once we get the earnings per share we're trying to get the earnings of the company here, are gonna be the, that represents the income minus the expenses. So that's what the company has earned which from a normal accounting standpoint would increase the equity side of the balance sheet. And so that would increase the value of the company assets minus liabilities is equity which represents the ownership by the shareholders. But then you gotta take into consideration well how are you gonna divvy that equity up between all of the shareholders? So now we've got an increase in the value to the company. How do I divvy that up? Well we're gonna divide it by the number of shares that are outstanding so we can get it on that per unit basis so that we can then think about our own portfolio by multiplying that times how many shares we have. For example, we also of course will now be looking at the earnings per share on a per unit basis and possibly using that to help determine if the price is accurately priced, the market price of the stock that is outstanding which is determined by market factor and market forces supply and demand in other words. By dividing a company's share price by its earnings per share and investor can see the value of a stock in terms of how much the market is willing to pay for each dollar of earnings. Earnings per share is one of the many indicators you could use to pick stocks. So clearly if you're picking stocks, earnings per share is one of the fundamental calculations if you're picking individual stocks. If you have an interest in stock trading or investing your next step is to choose a broker that works for your investment style. Comparance earnings per share in absolute terms may not have much meaning to investors because ordinary shareholders did not have direct access to the earnings. Instead, investors will compare earnings per share with the share price of the stock to determine the value of earnings and how investors feel about future growth. So in other words, the earnings itself although in theory it's the value that's increasing the value of the corporation to the owners of the corporation we as the stockholders cannot typically ask for that value to be given to us in the form of say dividends at least not directly, right? Because the management and the board of directors are gonna have to determine the dividends. What we're looking for is to see how the market is reacting to this earnings per share and how it's being reflected in basically the market price to help us make our decisions. So basic earnings per share versus diluted earnings per share, the formula in the table above calculates the basic earnings per share of each of these selected companies. Basic earnings per share does not factor in the dilutive effects of shares that could be issued by the company when the capital structure of a company includes items such as stock options, warrants or restricted stock units or SU. These investments if exercised could increase the total number of shares outstanding. So you might have these instruments that are out there that have this feature which could be converted to common stock. And if they would, that would mean there's more common stock out there which would have a diluting factor on the earnings per share. So you might say, well, what would happen if those were all exercised? What would the earnings per share be in that case? That would be the diluted earnings per share because it would be lower than the normal earnings per share if any of these instruments were out there. So to determine, to better illustrate the effects of additional securities on earnings per share companies, also report the diluted EPS earnings per share which assumes that all shares that could be outstanding have been issued. For example, the total number of shares that could be created and issued from NVIDIA's convertible instruments for the fiscal year that ended 2017 was 23 million. If this number is added to its total shares outstanding, its diluted weighted average shares outstanding will be 541 million plus 23 million equaling 564 million shares. The company's diluted EPS earnings per share is therefore 1.67 billion divided by 0.564 million which equals 2.96%. Sometimes an adjustment to the numerator is required when calculating a fully diluted earnings per share. For example, sometimes a lender will provide a loan that allows them to convert the debt into shares under certain conditions. The shares that would be created by the convertible debt should be included in the denominator of the diluted earnings per share calculating. But if that happened, then the company wouldn't have paid interest on the debt. In this case, the company or analyst will add the interest paid on convertible debt back into the numerator of the earnings per share calculation so the results isn't distorted. So this gets a little bit complex here, but obviously when you have these different events, what's happening here is if the conversion kind of feature happened, then these other things would take place. So if you're assuming the conversion to take place, you're trying to take all those factors into considerations. So earnings per share excluding, we might do some examples, by the way, so you can get a better idea of that in Excel possibly. Earnings per share excluding extraordinary items. Earnings per share can be distorted both intentionally and unintentionally by several factors. Analysts use variations of the basic earnings per share formula to avoid the most common ways that earnings per share may be inflated. So imagine a company that owns two factors that make up cell phone screens, two factories. They make cell phone screens. The land on which one of the factories sits has become very valuable as new developments have surrounded it over the past few years. So now the land has gone up in value just for reasons outside of the company's control. So the company management team decides to sell the factory and build another one on less valuable land. This transaction creates a windfall profit to the firm. So they built a company and they probably built it in a place that was cheap, right? And then a city grew around the company which made that land more valuable at that point in time. They're like, well, why don't I sell the land, take the gain on the land that we just happened to get just from the land going up and then build our factory in some other place resulting in this windfall profit to the company. So though this land sale has created real profits for the company and its shareholders, it is considered an extraordinary item because there's no reason to believe the company can repeat that transaction in the future. In other words, the company is not in the business of buying and selling land. It just so happens that they made out on that deal. And the problem is that that's not gonna happen in the future again. So if you factor that in to past performance to try to project what they're gonna do in the future, it's gonna be distorted because that was a one-time thing. So shareholders, that'd be like someone winning the lottery and now you're gonna predict that they're gonna win the lottery again because they won it last time. It's like, no, they got lucky. Shareholders might be misled if the windfall is included in the numerator of earnings per share equation. So it is excluded. So a similar agreement could be made if a company has an unusual loss, maybe the factory burned down. So you could be unlucky instead of lucky and have this loss and say the factory burned down and now you've got this big loss that happened. Well, that's gonna make you look bad if you were to factor it in and predict that it's gonna happen again next year, but it's not gonna happen next year. Unless it was a one-time thing, we hope which would have temporary decrease the earnings per share and should be excluded from the same reason. So the calculation for EPS excluding extraordinary items is earnings per share equals the net income minus the preferred dividend plus or minus the extraordinary items because again, those extraordinary items are not gonna give us any future predictable information. They're gonna distort the purpose of the number which is to help us to determine what's gonna happen in the future from past events, extraordinary items being the one-time events which we don't expect to have any impact on future events divided by the weighted average common shares. So earnings per share from continuing operations, a company started the year with 500 stores and had an earnings per share of $5. However, assume that this company closed 100 stores over that period and ended the year with 400 stores. An analyst, I will want to know what the earnings per share was for just the 400 stores the company plans to continue with into the next period. So again, you've got the same kind of thing here. If you had 500 stores last time and now you've only got the 400, I want predictive information going into the future. So the 100 stores that are no longer there are not a factor to me on the margin as economists would say at this point in time going forward. And this example, that would increase the EPS earnings per share because the 100 closed stores were perhaps operating at a loss by evaluating earnings per share from continuing operations. An analyst is better able to compare prior performance to current performance. So earnings per share and capital an important aspect of earnings per share is that is earnings per share that is often ignored is the capital that is required to generate the earnings net income in the calculation, meaning the assets that the company has in order to generate the revenue. Two companies can generate the same earnings per share but one could do so with fewer net assets. So remember that when you're looking at earnings the company is there to generate the earnings and the way they generate the earnings is they invest in assets. Now notice when we use the term investing it can be kind of confusing because we're investing in companies you think of investments as investing in stocks and bonds but companies, the assets on the company's books are investments. In other words, the only reason they have the assets a company because it's just a shell it's a company that's there to generate revenue. The only reason they're holding onto assets is not because they like Scrooge McDuck and they have a pile of assets they need to be using those assets to generate revenue otherwise they're pointless to be in the company they should be giving them to the owners of the company to the shareholders. So they're investing in assets like equipment and buildings and whatnot and those then assets are being used to generate revenue. So we wanna be able to think about how efficiently are the companies using their assets to generate revenue. So if two companies could have a similar revenue generation but one company might be doing so with less assets in a similar industry you would think they'd be doing a more efficient job. So that company would be more efficient at using its capital to generate income and all other things being equal would be a quote better end quote company in terms of efficiency. A metric that can be used to identify more efficient companies is the return on equity that's the ROE. So earnings per share and dividends. Although earnings per share is widely used as a way to track a company's performance shareholders do not have direct access to those profits. So we can't draw the money out like we could if it was a partnership we could vote for the board of directors to try to get them to pressure them to do that but we can't just simply get direct access to the money. A portion of the earnings may be distributed as dividends but all or a portion of the earnings per share can be returned by the company, retained by the company. So the company is gonna decide through the board of directors and the management whether or not to give that earnings to the investors in the form of dividends and that will be dependent upon whether the company wants to keep the earnings and grow which would be good for investors if they increase the sales price or whether they wanna be giving the money to the shareholders in the form of dividends. Shareholders through their representatives on the board of directors would have to change the portions of the earnings per share that is distributed through dividends to access more of those profits. Earnings per share and price to earnings per share, the PE. So making a comparison to the PE ratio within an industry group can be helpful though in unexpected ways. Although it seems like a stock that costs more relative to its earnings per share when compared to peers might be overvalued the opposite tends to be the rule. Regardless of the historical earnings per share investors are willing to pay more for a stock if it is expected to grow or outperform its peers in a bull market. It is normal for the stocks with the highest PE ratios in a stock index to outperform the average of the other stocks in the index. We might talk more about the PE ratio in a future presentation. What is a good earnings per share? What counts as a good earnings per share will be dependent upon or on factors such as the recent performance of the company, the performance of its competitors and the expectations of the analysts who follow the stock. So clearly where it's all relative, we're gonna be comparing how they did compared to similar companies in a similar nature and what we budgeted or what the market thought they were gonna do. Sometimes a company might report growing earnings per share but the stock might decline in price if analysts were expecting an even higher number. So even doing good might not be good enough if the analysts thought that you were gonna do really good. So likewise a shrinking earnings per share figure might nonetheless lead to a price increase if analysts were expecting an even worse result. So even if you have a bad number it might not be as bad as they were thinking. So it is important to always judge earnings per share in relation to the company's share price such as by looking at the company's PE or earnings yield. What is the difference between basic earnings per share and diluted earnings per share? Analysts will sometimes distinguish between basic and diluted earnings per share. Basic earnings per share consists of the company's net income divided by its outstanding shares. It is the figure most commonly reported in the financial media and is also the simplest definition of earnings per share. Diluted earnings per share on the other hand will always be equal to or lower than the basic earnings per share because it includes a more expansive definition of the company's shares outstanding. Specifically, it incorporates shares that are not currently outstanding but could become outstanding if stock options and other convertible securities were to be exercised. What is the difference between earnings per share and adjusted earnings per share? Adjusted earnings per share is a type of earnings per share calculation in which analysts make adjustments to the numerator. Typically, this consists of adding or removing components of net income that are deemed to be non-recurring. So for instance, if a company's net income was increased based on a one-time sale of a building, the analyst might deduct the proceeds from that sale, thereby reducing net income. And that scenario, the adjusted earnings per share would be lower than the basic earnings per share. What are some limitations of earnings per share? When looking at earnings per share to make an investment or trading decision, be aware of some possible drawbacks. For instance, a company can game its earnings per share by buying back stock, reducing the number of shares outstanding and inflicting earnings per share by giving the same level of earnings. So changes to accounting policy for reporting earnings can also change earnings per share. Earnings per share also does not take into account the price of the share. So it has little to say about whether a company's stock is over or undervalued. So how do you calculate earnings per share using Excel? After collecting the necessary data, input the net income, preferred dividends and number of common shares outstanding into three adjacent sales, say B3 through B5. In cell B6, input the formula B3 minus B4 to subtract preferred dividends from net income and sell B7, input the formula B6 divided by B5 to render the earnings per share. We might do that in Excel in some practice problems later.