Earnings Per Share - EPS

Earnings per share, or EPS, represents profits which accrue for the shareholders on a per share basis and can be found on the income statement.  This figure is very important as it allows investors and analysts to determine the price to earnings ratio

Earnings Per Share (EPS) Formula

The numerator in the formula above represents earnings while the denominator represents number of outstanding shares.  Outstanding shares is easy enough so we will cover that first.  EPS calculations use a weighted average of common stock outstanding over the entire reporting period as this number can fluctuate if a company decides to issue stock or engage in a stock buyback.  Therefore, a weighted average gives a smoothed effect and is the preferred technique. 

There is a second way of calculating the outstanding shares and this method is more conservative as it includes all current outstanding shares plus all derivative obligations which could turn into stock, such as stock options or warrants.  As you can see, increasing the denominator will decrease the EPS number. 

Now, the derivation of the EPS is not as simple as it seems.  Companies report one set of financial statements for tax purposes and one set for their investors.  Therefore, when you hear about different types of EPS calculation, you should understand what goes into each of them.  We will cover Reported EPS, Ongoing EPS, Headline EPS, and Cash EPS.  

Reported EPS 

This number is what is reported in the SEC filing and should be taken with a grain of salt. It can be manipulated directly or indirectly.  Some companies can get into very creative accounting practices and distort the earnings numbers.  Indirectly, companies can include one time sales which can inflate earnings or one time charges which can deflate them.  You need to read the fine print. 

Ongoing EPS

Ongoing EPS, pro-forma EPS attempts to step in where reported EPS is deficient.  This calculation strips out one time events and attempts at using earnings that originate from the companies core operations to get a better understanding of the companies longer term, recurring streams of income and also allows for longer term forecasts.

Headline EPS

Headline EPS is the number you see plastered all over CNBC and in the marketing materials for a company.  This is typically a Wall Street analysts' expectations of earnings for a company and one should take this number with a grain of salt.

Cash EPS

Cash EPS, which is considered the purest indicator of EPS, divides operational cash flows by the common shares outstanding + potential future share liabilities (stock options, warrants, etc.).  The dilution of this number also makes it the more conservative number.

Cash EPS is just that; it provides the investor with the understanding of whether the company is fundamentally able to generate cash.  Operational cash flows include inventory, accounts receivables, and short term investments, to name a few examples.  It is a strong indicator if cash EPS is higher than reported EPS; it tells us that we are dealing with a more fundamentally sound business which makes real money.

Trading Stocks In Anticipation of Earnings

It is generally considered gambling if you are placing bets on whether a company will be reporting earnings in line or above their earnings estimates.  Remember, even if the company reports better earnings, it may be due to one time events that are not truly indicative of the health of the company.
Tim Ord
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