Understanding Earnings Per Share (or EPS)

Earnings means profits. Before you buy a share , this is the first figure that you need to check. An increase in earnings every year is a sign that the company in question is prima facie a good candidate for further analysis. Increasing earnings generally leads to a higher stock price. Most of the high earning companies also pay regular dividend to its shareholders. Analyzing Earnings is the first most important step for investors because they give an indication of the company’s expected future dividends and its potential for growth and capital appreciation. The other names by which earnings are called are – Profits , Income etc.. ( But not ‘Revenues’. That’s a totally different term !)

THE BASICS.

Earnings simply are the company’s profit – how much money did it make in any given period.How does a company calculate earnings ? It’s by deducting the ‘cost of sales’ , ‘operating expenses’ and ‘taxes’ from it’s total sales revenues. The term ‘cost of sales’ is nothing but the total amount incurred of raw materials, labour and other expenses incurred in producing a product for sale. The term ‘operating expenses’ means the cost incurred for operating the business such as salary to staff, legal expenses, advertisement etc.. and taxes are those payments made to the government on the income that’s generated.

POSITIVE EARNINGS.

Investors expect established companies like Infosys to declare high earnings. If they report lower earnings for a quarter, the stock price would immediately tumble. New or Young companies, on the other hand, may go for years with negative earnings and still enjoy the favor of the market if investors believe in the future of the company.

Companies are required to declare it’s earnings figures every quarter.

In India, A financial year starts from 1st of April and ends on the subsequent march 31st. So the quarters are as follows-

Quarter 1 -1st April to 30th June. Earnings for the quarter will be declared in July
Quarter 2 – 1st July to 30th Sept. Earnings for the quarter will be declared in Oct.
Quarter 3 – 1st Oct to 31st Dec . Earnings for the quarter will be declared in Jan.
Quarter 4 – 1st Jan to 31st Mar . Earnings for the quarter will be declared in April.

Companies also declare half yearly results clubbing two quarters. Investors, based on the given facts, try to figure out the expected earnings of the company. This expectation of the investors is what is actually reflected in the share price movements. So, in addition to the actual earnings, the expectation of earnings also play an important part in stock prices . Companies that fail to meet the expectations of the investors gets beaten by the market. Earnings (or growth towards positive earnings) tell you how healthy a company is.

EARNINGS PER SHARE.

The basic measurement of earnings is “earnings per share” or EPS. This measurement divides the earnings by the number of outstanding shares. For example, if a company earned Rs 150 Crores in the third quarter and had 75 Crore shares outstanding, the EPS would be Rs 2 (150 / 75).

WHY EPS?

The reason you reduce earnings to a per share basis is to compare it with another company. For example – Two companies A and B has earned a profit of 150 crores each.Which one would you prefer? Both seems to be ok with you. Right? However, if I say that company A has 75 Crore shares outstanding and company B has 100 crore shares outstanding, which one would you prefer? Your answer lies in the EPS figure.

Company A has an EPS of 2 ( 150/75) whereas company B has an EPS of just 1.5 (150/100). So you prefer the company A that pays you more profit per share.

It’s importants to note here that the EPS is helpful in comparing one company to another, assuming they are competing companies of the same category ( large cap or small cap etc..) in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it.

EARNINGS PERIOD.

As said earlier, companies report earnings every quarter. April-June is Quarter 1 generally termed as ‘Q1’, July –Sept is quarter 2 or ‘Q2’and so forth. Generally , the quarter results come out by the mid of the subsequent quarter. The market always approaches the earnings reporting day with caution.That day can be a time of some volatility, either up or down for particular stocks and/or sectors.

TYPES OF EPS

The numerator and denominator in an EPS equation can change depending on how you define “earnings” and “shares outstanding”.

Let’s try to crack the numerator (Earnings) first.

There are three types of Earnings numbers:

  • Trailing earnings – last year end earnings figure.
  • Current earnings – current year’s number- part actuals,part projections based on the current performance.
  • Forward Earnings – future numbers which are pure estimates.

EPS calculated with the last year end actual earnings figure is called “trailing EPS”. trailing EPS is the actual EPS figure.
When Current earning estimates are used to compute EPS , it’s called the “Current EPS” and when Future earnings figures are used, it’s called “forward EPS”.

Now, Let’s see the denominator part. (ie Shares outstanding)

Shares outstanding can be classified as either Basic or fully diluted

  • Basic EPS is calculated using the number of shares that have been issued and held by investors. These are the shares that are currently in the market and can be traded.
  • Basic Earnings per share (Basic EPS) tells an investor how much of the company’s profit belongs to each share of stock.

The number calculated this way excludes any possible dilution stemming from outstanding dilutive securities, such as options, warrants, convertible bonds, or convertible preferred stock. Diluted EPS reflects the potential dilution from such dilutive securities. The companies that don’t have any dilutive securities, or the companies that report net losses, report only Basic EPS.

In short, EPS computed can be Trailing EPS (Diluted or basic) or Forward EPS (Diluted or basic).

Know it

  • Earnings means Profits. The term should not be confused with ‘Revenues’ which is a totally different term
  • Companies report earnings every quarter i.e April-June (quarter 1 or Q1) Jul-sept (Q2) so on..
  • The stock market approaches each earnings report with caution.
  • Markets will react positively on a company that declares positive earnings growth. The reverse is also true.
  • The basic measurement of earnings is EPS
  • EPS computed can be Trailing EPS (Diluted or basic) or Forward EPS (Diluted or basic).

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Some truths about stock markets

Hi there,

From this post onwards, I am going to kick off the discussion on shares as an option to create wealth. Let me start by saying 7 straight truths about stock markets.

First, nobody gets rich quickly in stock markets. Some of your friends might have blindly invested in some stocks which, to their luck, gave them exceptional profits. Yet, they never became rich. Did they? So that’s the first truth about stock markets – it’s not a place where you  get rich quickly.It takes time to grow your money.

Second, it isn’t easy for beginners to make money on the stock exchange. If it was such a simple exercise, Mr. Warren buffet wouldn’t have become so famous. It takes genuine effort to spot profitable investments.

Third, your broker, friends, neighbor, colleagues et al would come up with ‘sure shots’ everyday; there are too many stock analysts out there giving out fee based stock recommendations. It’s easy to get tempted by all these people around you. After many years in the market, my thoughts keep wavering when somebody comes up with such ‘sure shots’. Should I explain the fate of a beginner? It’s important to stay off from these temptations. It implies that you ought to have ‘independent thought’. Independent thought is something very hard to carry through.

Fourth, most of the investors are a bit too casual with stock markets. They ‘play’ in stock markets.  Stock exchange is a wrong place to have fun, speculate and try luck. The Stock market is actually a place dominated by big investment houses and financial experts. This is a place where the world’s brightest finance professionals put their best efforts to make right investment decisions. Nobody is playing around. So, to be successful, you too, need to be serious. You have to view it as a business. When you buy shares, you are buying a company to that extent. Buying a company is no Fun!

Fifth, realise the fact that broker’s income is the commissions you give. The more you trade, the more they get. When I was serving as the manager of a broker, I used to get monthly targets for the volume of brokerage that should be generated. If I don’t do that, my salary payment gets delayed. Each branch was viewed as a profit center. Myself and my colleagues used to hit our targets but our investors rarely did! Most of the brokerage houses encourage their clients to do as many trades as possible whether it’s good for them or not, and keep doing it until you have used up all their money. If you get too many frequent ‘Sure shot market tips’ thru sms, mails and phone calls – think twice. Your broker may be interested only in generating commissions. Make sure you don’t get into such traps. Do have faith in your broker, but don’t blindly follow them. They can give you advice but they can’t guarantee that you will make a return on any investment in the stock market.

Sixth, as you begin to study the principles, you’ll hear about derivative instruments like futures and options. Instruments like  options and futures are NOT for  beginners with limited resources. They are highly technical, involve the potential to lose all of your investment quickly and need constant monitoring. Playing Futures and options without adequate working knowledge is like gambling at Las Vegas.

Finally, you have to keep on working on your stock picking skills.  Keep following the market developments. You’ll also need to study some basics on economics, accountancy, income tax and mathematics.

So, # No quick riches in stock markets # it’s not the place to have  fun with money # you shouldn’t be blindly believing your broker’s recommendations # never try your luck # and,  learning is the only way -to make  right choices in stock markets.

So, let’s begin from the roots. My next post would explain what shares are.

Before you take the plunge, think about what’s said above.  To succeed in stocks, you’ll have to put maximum efforts to learn the game and be serious with investments.

May God help you to achieve your goals.

Bye!!

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The components of financial statements

THE COMPONENTS OF FINANCIAL STATEMENTS

In the last article we said that financial statemenst are prepared on monthly / quarterly /half yearly and annual basis. Now, irrespective of the time period, financial statements ( or ‘financials’ as it is called in common parlance) basically consists of three parts:

  • Income statement or Profit and Loss account
  • Balance Sheet
  • Cash flow statement

Most of the figures shown in the annual financial statements will be in a summarized form since – for example the total of all the assets like machinery, buildings, plant, tools, vehicles, computers etc will be shown in the balance sheet as ‘fixed assets’. If you want to know about the details of fixed assets, you may have to refer to the schedule of fixed assets attached with the balance sheet. A big company may have many more schedules like the one mentioned above.

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Introduction to financial statements


From the last two articles we know that financial statements are part of a broad report call annual report. Now we proceed to understand what financial statements are. Law requires corporate entities to keep correct financial records of all the transactions. This is because; the company does business with the money of the public (shareholders).In order make sure that these funds are utilized properly, law makes it mandatory for companies to keep systematic record of all financial transactions. From these financial records, the annual profit or loss from the business is ascertained by an independent qualified auditor. This audited statement forms part of the annual report.

FIRST THINGS FIRST

The very first point you have to understand is that apart from annual financial statements, these are also prepared on monthly , quarterly and half yearly basis so that the management has absolute control over what’s happening and they are up-to-date with the financial position of the business. Quarterly statements will be published every three months, half yearly statements after the end of six months of operation and the final statement for the whole year will be published after twelve months of business. Out of these, the full year official audited statements (or annual financial statements) are the most important ones since, as said above, it presents the grand summary of business done in a year and it’s is also checked and certified by an independent financial auditor.

This doesn’t mean that quarterly and half yearly statements have no importance to the investor. They are important too. Since Quarterly / half yearly statements provide a summary of what has happened in the last 3/6 months, these figures are used by analysts to judge whether the company’s performance is up to the mark as expected. Analysts may also make projected or estimated figures using these statements and predict about the probable performance of the company.

Another important use of these quarterly statements is that it is possible to compare the performance from quarter to quarter. Such comparisons may reveal certain important aspects of the business- for example, the seasonal nature of the business. A company’s ability to hit the estimates expected by the investors every quarter also affects the market price of its shares. For example – If the quarterly financial result of a company exceeds investor’s expectations, you can witness a jump in its share price. So all these statements has its own importance.

A WORD OF CAUTION: as said above, analyzing quarterly or half yearly statements are good. However, it doesn’t not mean that you can rely on it totally. That’s because, it’s possible that a company that has shown promising results in the first quarter may face difficulties going forward. Uncertainty is a big factor in business. Predictions of all the market experts and brokers can go wrong. Why should we say about brokers? Those CEOs themselves can go wrong in certain cases.

now that you’ve got an idea about financial statements in general, our next article will explain the components of financial statements in detail.

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