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EPS is a
complicated calculation
Many businesses are sophisticated; the accounting may
become complex, and not as straightforward as one might like. There is no
simple solution or answer as to how much a company makes per share. What
seems simple on the surface is, in actuality, difficult.
Look at the EPS calculation. It’s calculated by
taking net income available for common shares, divided by the
weighted-average number of common shares outstanding. Net income, however,
is not a vanilla figure. Net income must first be reduced by any dividends
paid to preferred shareholders. Companies can also have net income from
continuing operations and discontinued operations; there can be accounting
changes, as well as unusual items. If there are acquisitions, investors will
need proforma income or cash flow income.
The basic weighted-average number of shares
outstanding may also be affected by common stock equivalents, such as stock
options and warrants, which dilute the weighted-average shares outstanding.
Companies, therefore, must report both basic and diluted EPS results.
Most investors use diluted earnings per share from
continuing operations, and compare the company’s growth from year to year,
to determine how a company is performing and a fair value for the stock
price.
To further complicate EPS, companies are also
charging comprehensive income adjustments directly to shareholders’ equity.
More and more companies are thereby reporting both increasing net income,
and shrinking shareholders’ equity. If this trend continues, the need to
report a comprehensive EPS is going to become more critical.
Astute investors, therefore, need to look beyond
press releases, news articles, summary annual reports and even research
reports. Go to the original SEC documents; they usually contain the audited
financial statements, showing the complete picture.
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