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Reported Earnings (EPS)

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Earnings per Share

Calculation of Accounting or Reported Earnings. Abstract

 

Reported Earnings (RE), and its derivative earnings per share (EPS), is a traditional method used for determining corporate value and can be calculated by subtracting the dividends on preferred stock from net income, and dividing the result by the (weighted average of the) combination of all outstanding common shares and all common stock equivalents (figure)


Fully Diluted EPS means that all common stock equivalents (convertible bonds, preferred stock, warrants, and rights) have been included along with the common stock.


Anyway, EPS (=accounting earnings, = reported earnings) is and has always been a poor indicator of corporate value!


Five major reasons why EPS fails to reliably measure the economic value of firms are:
1. Alternative accounting methods may be employed (both required changes by FASB or IAS and voluntary changes can change reported E., but do not affect economic value)
2. Risk is excluded (both business risk and financial risk are not accounted for in annual reports)
3. Investment requirements are excluded (changes in for example the working capital are not considered in reported E.)
4. Dividend policy is not considered (for example dividend decreases will show increased reported E. but are in fact value neutral)
5. The time value of money is ignored (no present value calculation in reported E.)
 

In the last 10 years, an additional 6th major reason has appeared:
6. The increased role intangibles play in our economic system, which has moved from an industrial economy towards a services and knowledge oriented economy.
 

Despite Enronitis, EPS is still being widely used in many annual reports.


Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Book: Ciaran Walsh - Key Management Ratios -


Compare with Earnings per Share:  EBIT  |  EBITDA  |  P/E Ratio  |  Economic Value Added  |  Cash Ratio  |  Current Ratio  |  Return on Equity  |  Fair Value  |  Return on Invested Capital

 

More valuation methodologies

 

 

 

 

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