KPI of the Day – Accounting: $ Earnings per share (EPS)
Definition
Indicates the net profit generated in one reporting period for each ordinary share outstanding, including common stock equivalents. The net profit is adjusted by the dividends on preferred shares when appropriate.
Purpose
To provide an indication of the companies’ ability to make money. The higher the EPS, the more valuable the shares are. It is a measure of return on shareholders’ investment.
Recommendations
In their company analyses, stock experts commonly rely on $ Revenue and $ EPS figures. A well-performing organization will have increases in both $ EPS results and $ Revenue numbers. A high-performing organization will almost certainly have $ EPS figures growing faster than $ Revenues. An efficient management system implementation is generally reflected in the quality of the $ EPS. The optimal way to evaluate $ EPS quality is by balancing it with $ Operating cash flow per share.
If the operating cash flow divided by the number of shares a specific company holds, is greater than its reported $ EPS, it means that the company is generating higher earnings than reflected by its income statement. This outlines the company’s high-quality earnings and sound operating results.
Some solid practices inadequately evaluating a company in regard to its $ EPS include:
- Evaluating specific trends in the industry;
- Correlating $ EPS results with trends in economic cycles;
- Relating $ EPS quality to revenue;
- Balancing $ EPS with $ Operating cash flow per share.
There are three types of EPS numbers: 1. Trailing EPS – last year’s numbers and the only actual EPS; 2. Current EPS – this year’s numbers, which are still projections; 3. Forward EPS – future numbers, which are obviously projections. Note that the last year’s EPS are actual, while current year and forward year EPS would be estimates. When interpreting EPS, it is worthwhile to explore the financing activities of the company.
Factors influencing the accuracy of EPS as an indicator of the company’s value:
* Alternative accounting methods may be employed (earnings manipulation affecting the quality of the figure);
* Investment requirements and/ or risk excluded (business and financial risk are not accounted for in annual reports);
* Dividend policy not considered (dividend decreases showing increased earnings, when in fact neutral);
* The time value of money is ignored, as there is no present value calculation in reported earnings.
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