# Diluted earnings per share



## viciam (14 July 2012)

Hi all,

I am teaching my self how to work out diluted earnings per share but I'm having some real issues with this and its doing my head in. I've been trying to work this out for the last 3 days and I'm not getting it.

There's so many things to take in to account like options, warrants and other dilutive securities. Can someone please help, provide me an example or explain how to work it out

Your help will be extremely appreciated

Thank you


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## burglar (14 July 2012)

http://www.investopedia.com/terms/d/dilutedeps.asp#axzz20W7FPP40


"Definition of 'Diluted Earnings Per Share - Diluted EPS'

A performance metric used to gauge the quality of a company's earnings per share (EPS) if all convertible securities were exercised. Convertible securities refers to all outstanding convertible preferred shares, convertible debentures, stock options (primarily employee based) and warrants. Unless the company has no additional potential shares outstanding (a relatively rare circumstance) the diluted EPS will always be lower than the simple EPS."

My Example:

I sell you 1 share with free attaching option.
You exercise that option.
You will then have two shares.
In this way, an option is a future share.


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## viciam (14 July 2012)

Hi thanks for the reply,

I understand the concept of Diluted Earnings per share

But I am trying to work out the calculation using an annual report and I just don't know what to look for


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## burglar (14 July 2012)

viciam said:


> Hi thanks for the reply,
> 
> I understand the concept of Diluted Earnings per share
> 
> But I am trying to work out the calculation using an annual report and I just don't know what to look for




Sorry. 
I buy pennydreadfuls and make money in bull markets and lose it again in Global Financial Crises.
I am not the best person to reply.
I don't understand much about where your at and where your headed?!
I just like to be helpful and perhaps get my head around these things in so doing.

Cheers,


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## viciam (16 July 2012)

Im a novice at investing, only started doing it this year. Reading as much as I can

Theres just so much to learn and to take in but Im enjoying it more than anything else Ive done in my life so far. I've bought some stocks in financially strong companies despite the weak overall industries with the hope of seeing returns once the economy improves. But I dont want to work on hope. I want to know what I am doing. I want to master this so badly but I dont know anyone personally who is into investing. I just wish I knew someone who could answer all the questions I have. 

Im tryin to learn how to work out diluted eps by going to yahoo finance for the company I am interested in, looking at the diluted eps shown there, then going into the annual report to find out how yahoo came to the diluted eps figure for that company but not having any luck at the moment


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## skc (16 July 2012)

viciam said:


> Im a novice at investing, only started doing it this year. Reading as much as I can
> 
> Theres just so much to learn and to take in but Im enjoying it more than anything else Ive done in my life so far. I've bought some stocks in financially strong companies despite the weak overall industries with the hope of seeing returns once the economy improves. But I dont want to work on hope. I want to know what I am doing. I want to master this so badly but I dont know anyone personally who is into investing. I just wish I knew someone who could answer all the questions I have.
> 
> Im tryin to learn how to work out diluted eps by going to yahoo finance for the company I am interested in, looking at the diluted eps shown there, then going into the annual report to find out how yahoo came to the diluted eps figure for that company but not having any luck at the moment




There are many things out there that can expand the shares outstanding (and hence dilute earnings) and not all of them are listed, or easily assessed. E.g. convertible notes you may have to look through the whole issue document to see what the terms are, if there were any special conditions or subsequent agreement to change the conversion rate etc.

My guess is that Yahoo just get the diluted EPS from the annual reports directly. Now whether it is possible, easy or meaningful to work it out from all the raw data is another matter.


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## craft (16 July 2012)

skc said:


> Now whether it is possible, easy or meaningful to work it out from all the raw data is another matter.




I suspect you would only want to do this if it was to answer an exam question or some other academic reason. It’s not the diluted EPS number that is important but how management treat the company’s currency.

From my perspective I am interested in whether the dilution results from management selling the equity for at least a fair value. If they have not then that’s not only a drag on valuation but more importantly a really big red flag about management’s custodianship.  If management are also the recipients of the undervalued options etc then that benefit better be clearly justified and notified or the company is a total no go zone for me.


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## viciam (16 July 2012)

craft said:


> I suspect you would only want to do this if it was to answer an exam question or some other academic reason. It’s not the diluted EPS number that is important but how management treat the company’s currency.
> 
> From my perspective I am interested in whether the dilution results from management selling the equity for at least a fair value. If they have not then that’s not only a drag on valuation but more importantly a really big red flag about management’s custodianship.  If management are also the recipients of the undervalued options etc then that benefit better be clearly justified and notified or the company is a total no go zone for me.





Thanks skc and craft. 

Craft, could you explain that a little bit better please, how would you know if management is selling equity for fair value. Where do you look to get this information?

Skc you said you have to look through the whole issue report and understand the terms of the options etc. i want to be able to do this. By issue report you mean annual report?


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## craft (16 July 2012)

viciam said:


> Thanks skc and craft.
> 
> Craft, could you explain that a little bit better please, how would you know if management is selling equity for fair value. Where do you look to get this information?




Because fair value is a subjective measure you can only judge this against your own opinion of value.

Basically, you don’t want management selling equity unless you yourself would sell at the price and you don’t want them buying back equity unless you yourself would buy at that price. (The exception is proportional dealings with existing holders)





> Skc you said you have to look through the whole issue report and understand the terms of the options etc. i want to be able to do this. By issue report you mean annual report?




If you really want to calculate yourself.

http://www.aasb.gov.au/admin/file/content105/c9/AASB133_07-04_COMPoct10_01-11.pdf

Being able replicate the accounting won't necessarily make you a good investor.


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## skc (16 July 2012)

viciam said:


> Skc you said you have to look through the whole issue report and understand the terms of the options etc. i want to be able to do this. By issue report you mean annual report?




What I meant was certain instruments (e.g. convertible notes) have specific terms about conversion price / ratio / time period etc. You will have to look at the report / document associated with the issuance (which may or may not be in the public domain) to determine dilution from that particular instrument. You will probably also have to go through all the company announcements in order to make sure that those terms have not changed since the day the notes were issued.

And as Craft said, being able to do the accounting is one thing. What implication (if any) can you draw from those is another. Given that the annual report already gives you the diluted EPS figure, what does working it out from sketch offer you in terms of new information?

If you have good answers to those then by all means pursue what you are pursuing...


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## viciam (17 July 2012)

Because the best investors know everything inside out and have dedicated their entire lives to master investing. So I feel that for me to master investing I need to learn everything possible, from calculating ratios, analysing financial statements and interpreting fundamentals to how the super powerful can influence world events to effect stocks etc

I'm so lost as to what my opinions, values and expectations should be. I wish I could go into the brain of Graham, Buffet or Templeton and embrace their knowledge.






skc said:


> What I meant was certain instruments (e.g. convertible notes) have specific terms about conversion price / ratio / time period etc. You will have to look at the report / document associated with the issuance (which may or may not be in the public domain) to determine dilution from that particular instrument. You will probably also have to go through all the company announcements in order to make sure that those terms have not changed since the day the notes were issued.
> 
> And as Craft said, being able to do the accounting is one thing. What implication (if any) can you draw from those is another. Given that the annual report already gives you the diluted EPS figure, what does working it out from sketch offer you in terms of new information?
> 
> If you have good answers to those then by all means pursue what you are pursuing...


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## burglar (17 July 2012)

viciam said:


> Because the best investors know everything inside out and have dedicated their entire lives to master investing. So I feel that for me to master investing I need to learn everything possible, from calculating ratios, analysing financial statements and interpreting fundamentals to how the super powerful can influence world events to effect stocks etc
> 
> I'm so lost as to what my opinions, values and expectations should be. I wish I could go into the brain of Graham, Buffet or Templeton and embrace their knowledge.




Value investors do not control everything. 
Some predators amongst them are called traders!


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## viciam (17 July 2012)

Do you guys think this is a good way to invest...

Step 1:Read as much as I can about a business, once I find a sector or business that I like go to step 2

Step 2: For figures and numbers read professional analyst reports from analysts that work for big investment firms to judge the health of a business, that way I would have professional analysts providing me with numbers

Step 3. I believe my fundamentals are okayish, I'm an avid reader of of philosophy, history and human nature. Use my own intuition in fundamentals based on my knowledge to go for a business.

I'll give you an example of an investment I made based on this. A company in the solar industry is rated as one of the most financially strongest company in that industry by analysts. However the industry is performing crap right now because of supply and demand issues. But this will balance out because my brain tells me that once the bad companies die out from the supply and demand problems only the strongest will remain. And once the bad companies are gone, supply and demand will eventually balance out and things will pick up for the stronger companies. Then I did some research on the fact that Saudi Arabia plans on investing 109 billion USD in solar energy. So I do a bit of research into this and I find they recently held an event where solar players from around the world were invited. One of the companies that I was interested in was on that list that attended. This makes me think that people like to do business with people that they know personally so this solar company would have had the chance to meet the Saudi decision makers personally which could possibly mean them winning major contracts in Saudi. So based on the strong financials provided by the analysts and my intuition I went ahead and purchased stocks in this company. The company was trading close to all time low, its declined a little further since but I want to hold on to it in the hope that things will pick up. My reason for feeling that things will pick up is that history tells us good times and bad times are cyclical. 

Is my way of thinking good or bad? Pleas be honest and open about what you feel

Thanks


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## Klogg (17 July 2012)

viciam said:


> Because the best investors know everything inside out and have dedicated their entire lives to master investing. So I feel that for me to master investing I need to learn everything possible, from calculating ratios, analysing financial statements and interpreting fundamentals to how the super powerful can influence world events to effect stocks etc
> 
> I'm so lost as to what my opinions, values and expectations should be. I wish I could go into the brain of Graham, Buffet or Templeton and embrace their knowledge.




The best investors can understand the financial figures and relate them directly to reality. They can see that perhaps the reason for Current Assets increasing is due to an increase in Inventories, or that ROE is low because the company has a needlessly large cash holding that is earning minimal interest (a few simple examples).

I'm no expert at this by any means (skc and Craft are far more knowledgeable and experienced), but I have learnt that just knowing how to calculate something means zero - if that were the case, all accountants would be rich. It's the business knowledge, mixed with finance/accounting that really makes a difference (and probably even more than just that).

As for opinions, I look at things such as:
- Average P/E ratios for the market/sectors
- Working examples of valuations (where I could find them)
- Buffett's annual reports (he has a way with words that just makes it all click)
- Any other references (Books, Websites, forums - always make sure the opinion has merit)

In relation to the quality of investment, I always relate it to what I can get 'risk-free' (for me, that is an interest bearing account of ~5.5% atm). If I can substantially beat that, and the company has a healthy balance sheet, then I'll dig further. If not, keep looking.

As for Diluted EPS, the measure on it's own means nothing - but it is mentioned within many of Graham's book, and his purpose for calculating this is so the investor knows the 'worst case' scenario - essentially 'what if' everyone exercised their convertible securities (more than just options), how does this effect the company. 
The most common scenario of course being the exercise of options, creating a bigger pool of total shares and EPS will decline as a result.

And in regards to why you should calculate it - well, my reason is simply that I want to verify the data I'm being fed, and that it's calculated as to how I'd like to interpret the data.

That's a fat wall of text, but I hope it helps...


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## burglar (17 July 2012)

I just pinched this link from another post:
For viciam, The author, Marcus Padley, is a super-cool dude!! (IMO)

http://www.smh.com.au/business/thre...hile-the-sun-isnt-shining-20120713-221kj.html


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## viciam (17 July 2012)

Thanks for the link Burglar, will begin reading it after I post this.

Klogg, do you read Warren Buffets Berkshires annual report just to learn? or do you mean you read it because your an investor in Berkshire? Is there a lot of valuable info in Berkshires annual reports?


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## Klogg (17 July 2012)

viciam said:


> Klogg, do you read Warren Buffets Berkshires annual report just to learn? or do you mean you read it because your an investor in Berkshire? Is there a lot of valuable info in Berkshires annual reports?




Purely just a learning exercise. Every year, he has his 'words of wisdom' (I guess you can call it that). The two I found most interesting were around the danger of derivatives and another which addresses some aspects of counterparty/credit risk.

He has many others, which can be found HERE.

Interestingly enough, he also details how insurance companies work, how they use the 'float' to invest and how useful that is to his investment strategy. I found this quite fascinating, but it also taught me that I don't understand financial companies (e.g. banks, insurance) enough to invest in them without more homework.


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## skc (17 July 2012)

viciam said:


> I'll give you an example of an investment I made based on this. A company in the solar industry is rated as one of the most financially strongest company in that industry by analysts. However the industry is performing crap right now because of supply and demand issues. But this will balance out because my brain tells me that once the bad companies die out from the supply and demand problems only the strongest will remain. And once the bad companies are gone, supply and demand will eventually balance out and things will pick up for the stronger companies. Then I did some research on the fact that Saudi Arabia plans on investing 109 billion USD in solar energy. So I do a bit of research into this and I find they recently held an event where solar players from around the world were invited. One of the companies that I was interested in was on that list that attended. This makes me think that people like to do business with people that they know personally so this solar company would have had the chance to meet the Saudi decision makers personally which could possibly mean them winning major contracts in Saudi. So based on the strong financials provided by the analysts and my intuition I went ahead and purchased stocks in this company. The company was trading close to all time low, its declined a little further since but I want to hold on to it in the hope that things will pick up. My reason for feeling that things will pick up is that history tells us good times and bad times are cyclical.
> 
> Is my way of thinking good or bad? Pleas be honest and open about what you feel




Your analysis of the solar industry may or may not be correct, but there's a few steps missing between analysising the industry to investing in a company at the right price.

- When will supply and demand balnces out and at what price level?
- At that time, what would be the company balance sheet look like?
- At that price level, what will the profitability of the company be?
- How would the market (not you) translate that profitability into share price?
- Given the above, how much are you willing to pay given the uncertainty in your projections, time-value of money and required return?

Then there are other investment management issues like:
- How much am I willing to risk for this particular investment?
- What are some of the measureable data that I should monitor to make my hold/sell decision? 

IMHO, your time is better spent thinking / analysing the above, then to work out diluted EPS from scratch.


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## craft (17 July 2012)

burglar said:


> I just pinched this link from another post:
> For viciam, The author, Marcus Padley, is a super-cool dude!! (IMO)
> 
> http://www.smh.com.au/business/thre...hile-the-sun-isnt-shining-20120713-221kj.html




Nick Radge's managed growth portfolio has returned negative 5.36% for the last 12 months which is better than the ASX accumulation, but what seems to be  working even better at the moment is selective stock picking. If Marcus’s thrust is avoid a buy and hold market weight exposure – that’s one thing, but to chuck out value investing in what is essentially a very good stock pickers market is a different matter altogether.


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## Klogg (17 July 2012)

> once I find a sector or business...



If you find a sector, how do you then go about finding an outstanding business to match?



> Use my own intuition in fundamentals based on my knowledge to go for a business



This will help you identify a good business, but how do you know if it's cheap? What metrics are you looking at? Are you confirming these metrics? Do you see any warning signs in their financial statements?

In regards to the solar company, how do you know they're making good money? It could be the best idea, and the sector could be great, but if that particular business can't turn these into a profit, it's all quite useless.
Also on this point, are you aware of any risk arising from government policy? I don't know the solar industry well, but I'd imagine that while the carbon tax may help, what happens if the Coalition gets into power next election and removes the tax?
(Chances are you're looking at an O/S company, as you mentioned Saudi, in which case this point is moot)

And if you are investing in foreign companies, are you aware of the currency and sovereign risk that go with it?



> The company was trading close to all time low



Buying a company just because it's trading at an all-time low probably isn't the best idea... Imagine you bought QANTAS at $3.00 on the basis that it had dropped a lot.



> but I want to hold on to it in the hope that things will pick up. My reason for feeling that things will pick up is that history tells us good times and bad times are cyclical.



Holding onto something ONLY because you think the market will come back can be dangerous. Remember, your aim is to pick yourself the best investment, to get the best return. To do so, you need to understand why buying this particular company will return more than buying any other particular company.


To me it seems you have a stronger understanding of a macro view, but need to work on analysing a particular business and finding 'value'. A good starting place would be a book like 'The Intelligent Investor', or if you have decent accounting knowledge, 'Security Analysis' (this is my favourite by a mile).

Ofcourse, this is just my view - and after all, I'm just a random guy on a random thread...


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## burglar (17 July 2012)

Klogg said:


> ...
> (Chances are you're looking at an O/S company, as you mentioned Saudi, in which case this point is moot)... Ofcourse, this is just my view - and after all, I'm just a random guy on a random thread...




Hi random guy,
viciam is in the UK, the company is listed in the NYSE, the contracts are in Saudi Arabia ... the sun is shining on us in Australia.

PS Klogg, I like your view!


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## Klogg (17 July 2012)

burglar said:


> Hi random guy,
> viciam is in the UK, the company is listed in the NYSE, the contracts are in Saudi Arabia ... the sun is shining on us in Australia.
> 
> PS Klogg, I like your view!




Oops - failed on the location. Thanks burglar for picking that up


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## viciam (18 July 2012)

Klogg said:


> As for Diluted EPS, the measure on it's own means nothing - but it is mentioned within many of Graham's book, and his purpose for calculating this is so the investor knows the 'worst case' scenario - essentially 'what if' everyone exercised their convertible securities (more than just options), how does this effect the company.
> The most common scenario of course being the exercise of options, creating a bigger pool of total shares and EPS will decline as a result.
> 
> And in regards to why you should calculate it - well, my reason is simply that I want to verify the data I'm being fed, and that it's calculated as to how I'd like to interpret the data.
> ...




Hi Klogg, that's the reason why I want to be able to calculate all the ratios and estimates myself because I can't rely on other people to make calculations. Even the figures given in annual reports can't be trusted because a company will do everything it can in its legal power to enhance the reportings as much much as possible. This article I came across this morning explains it better http://winninginvestor.quickanddirtytips.com/the-five-types-of-earnings-per-share-numbers.aspx

There are so many tricks and tweaks that can be made to enhance EPS figures that are reported in annual reports which usually end up on places like Yahoo Finance, and because they are enhanced to give the best image of the company, it might not be the most realistic image of the company.  For me to be a good investor I feel that I need to know how to spot these and use to my advantage. But again I'm feeling a little afraid that there is so much to learn


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## viciam (18 July 2012)

skc said:


> Your analysis of the solar industry may or may not be correct, but there's a few steps missing between analysising the industry to investing in a company at the right price.
> 
> - When will supply and demand balnces out and at what price level?
> - At that time, what would be the company balance sheet look like?
> ...




SKC, How can I know what a companies balance sheet will look like once the supply and demand balances out?


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## viciam (18 July 2012)

Klogg said:


> If you find a sector, how do you then go about finding an outstanding business to match?
> 
> 
> This will help you identify a good business, but how do you know if it's cheap? What metrics are you looking at? Are you confirming these metrics? Do you see any warning signs in their financial statements?
> ...




Klogg once I find an industry that I've had interest in for a while, I will do a simple search of "Strongest companies in **** industry" 

There are then tons of analysis and articles highlighting the strongest financial companies, or companies with amazing intellectual property. Once I find a few that stand out I will dig a little further by trying to get an idea of what the management is like and get an understanding of their operations. The ones that I feel in my opinion have an advantage over the competition in some fundamentals, I will look into further.

In regards to metrics I have absolutely no idea what I am doing. I don't know if its cheap or expensive nor do I know what warning signs to look for. Although when in earning transcript calls they keep saying EBITDA figures I don't like it because interest, Tax and depreciation are a very real thing so whenever I hear CEOs using EBITDA it gives me the impression that there trying to give a more positive vibe during the call than what the situation really is. But to be honest I have no real idea of what warning signs can be found in the statements.

What do you mean by macro view?

I have bought the intelligent investor and am on the first chapter. 

In regards to solar, The price of producing solar energy compared with energy from oil/gas/nuclear is high but it is very rapidly coming to a level of being equal. This is playing a part in my hoping that the solar industry will improve  once the crap companies are gone and the price to produce solar energy on a large scale is price competitive with regular energy production.

Do you think my fundamental analysis is okayish? and my business valuation and financial statement reading sucks?

Please be honest and critical as you like

Thanks


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## burglar (18 July 2012)

viciam said:


> ...Please be honest and critical as you like
> 
> Thanks




Hard to be critical when *we all* are doing the best we can, with what we got.
In a bullish market your hard work would be rewarded manyfold.

But the current market is extremely difficult .... 
Normally I recommend that newbies dip a toe, to get some skin in the game. 
I also recommend learning as much as possible about the area they wish to pursue. 
In your case it would seem to be Value Investing.

In this market I would not recommend dipping a toe.
Tomorrow, next week, next month, it can all be different!


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## burglar (18 July 2012)

burglar said:


> Value investors do not control everything.
> Some predators amongst them are called traders!




How many shares are held by management?
Do you have access to top shareholders list?

I am guessing the 80:20 rule may apply.

Up to 80% of the shares might be held in safe hands (tightly held)!

The rest are "weakly held" and are vulnerable to Traders.
It is these shares that decide the Share Price Action.

As a Value Investor, do you put you head in the sand, 
while the market toys with the share price?
Do you continuously tell yourself all is well?
If the share price rises dramatically, do you sell or hold?
If it falls, do you buy more?


It's a hard game!!


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## viciam (18 July 2012)

burglar said:


> How many shares are held by management?
> Do you have access to top shareholders list?
> 
> I am guessing the 80:20 rule may apply.
> ...




Hi, what is the 80:20 rule and where can I get the list of top stockholders?


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## burglar (18 July 2012)

viciam said:


> Hi, what is the 80:20 rule and where can I get the list of top stockholders?




Not knowing which company, I had to guess the proportion of "tightly held" shares to "weakly held" shares
I have probably misused the 80:20 rule, but have a read of this!
http://en.wikipedia.org/wiki/Pareto_principle

An Australian company would have top shareholders in the Annual Report.

For your company (alas I do not know which one you have. I am guessing SPWR Sunpower),
you may wish to google?


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## Klogg (18 July 2012)

viciam said:


> In regards to metrics I have absolutely no idea what I am doing. I don't know if its cheap or expensive nor do I know what warning signs to look for. Although when in earning transcript calls they keep saying EBITDA figures I don't like it because interest, Tax and depreciation are a very real thing so whenever I hear CEOs using EBITDA it gives me the impression that there trying to give a more positive vibe during the call than what the situation really is. But to be honest I have no real idea of what warning signs can be found in the statements.




You mention EBITDA and how you don't like that measure. However, depending on what you're looking at, this could be very useful. What if the company had a huge one-off loss and their profits were demolished, yet their EBITDA was stronger than ever? Does that mean you don't invest in the company? (Like what happened with Rio Tinto and Alcan)

In my opinion, this is where your weakness lies. You need to be able to understand what the figures are and how they translate to reality.
A simple example is the price earnings ratio. This indicates how much you're paying in respect to the earnings power you're getting. If you're paying $100 for a share and the company only earns $1 per share, it'd take you 100years at the current rate for your portion of the company to pay itself off. A poor investment.
You'd need to understand this for most financial statements and ratios before you can judge whether a company is a good investment (many of these are covered in The Intelligent Investor).




> What do you mean by macro view?




The macro-economic view - basically the wholistic view of the economy and how it is performing, rather than per company




> In regards to solar, The price of producing solar energy compared with energy from oil/gas/nuclear is high but it is very rapidly coming to a level of being equal. This is playing a part in my *hoping* that the solar industry will improve  once the crap companies are gone and the price to produce solar energy on a large scale is price competitive with regular energy production.




This to me screams speculation, not investment. You should have an idea of what the company will return over the years (an idea, not exact measurements) in terms of earnings.




> Do you think my fundamental analysis is okayish? and my business valuation and financial statement reading sucks?
> 
> Please be honest and critical as you like




There a few basics that aren't being followed in your analysis, and these include:
- Measurement of the company's performance
- Understanding of its financial state
- 'Value' versus price understanding
- You're 'hoping' that the solar industry will improve is worrying. How much do you know about the industry?

To me, there's a lot more that you need to do/know before you can call it investing.



> In regards to metrics I have absolutely no idea what I am doing



Learn this!


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## yonobarn (18 July 2012)

viciam said:


> Hi all,
> 
> I am teaching my self how to work out diluted earnings per share but I'm having some real issues with this and its doing my head in. I've been trying to work this out for the last 3 days and I'm not getting it.
> 
> ...




Hi viciam,

In a previous life I worked as an equities analyst at an institutional stockbroking firm.  I agree with what others have written (ie - don't hang your hat on diluted EPS), however it is a super important figure for some companies, especially those with complicated capital structures.

If you are really keen to work out a diluted EPS figure, why not pick an example, and I will sharpen my pencil and will be happy to show you the 'answer' and the calculations used to get there?


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## viciam (18 July 2012)

yonobarn said:


> Hi viciam,
> 
> In a previous life I worked as an equities analyst at an institutional stockbroking firm.  I agree with what others have written (ie - don't hang your hat on diluted EPS), however it is a super important figure for some companies, especially those with complicated capital structures.
> 
> If you are really keen to work out a diluted EPS figure, why not pick an example, and I will sharpen my pencil and will be happy to show you the 'answer' and the calculations used to get there?




Hi Yonobarn, that would be awesome

I'm using ArcelorMittals diluted EPS and 2011 annual report as an example to teach myself. 

The annual report link is http://www.arcelormittal.com/corp/~...rs/annual-reports/AR2011-2012-03-13-final.pdf

The diluted EPS if I'm reading it correctly is $1.19, I can't work out how they came up with that number.

Thanks


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## Klogg (19 July 2012)

viciam said:


> Hi Yonobarn, that would be awesome
> 
> I'm using ArcelorMittals diluted EPS and 2011 annual report as an example to teach myself.
> 
> ...




I haven't crunched the numbers yet, but I did find:

"Diluted earnings per share is computed by dividing income available to equity holders and assumed conversion by the weighted average number of common shares and potential common shares from outstanding stock options as well as potential common shares from the conversion of certain convertible bonds whenever the conversion results in a dilutive effect."

And on top of page 145 is the figures for it.

At a quick glance, I can't tell you how they got 1.19 (I'm getting 1.40). When I get more time I'll have a better look.


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## viciam (19 July 2012)

Hi Klogg, 

I followed your advice on trying to understand numbers better but I too am getting $1.40. 

I also printed off the Berkshire Hathway letters you gave the link for and read through the 1979 letter already. I'm using a highlight marker to highlight all the important things mentioned, especially those that give an insight into Warren Buffets thoughts.

Much thanks for that


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## yonobarn (19 July 2012)

viciam said:


> I'm using ArcelorMittals diluted EPS and 2011 annual report as an example to teach myself.
> 
> The annual report link is http://www.arcelormittal.com/corp/~...rs/annual-reports/AR2011-2012-03-13-final.pdf
> 
> ...




Hi again viciam

You picked a tough one to cut your teeth on!

The answer lies in the spin off of Aperam.  Aperam contributed NPAT of $461m in FY11, so your numerator (E) drops from $2,263m to $1,802m.  Assuming your denominator (PS) stayed the same at 1,549m shares, you would get EPS of ~$1.16.

However, it doesn't...  The denominator increases by the 61.7m shares that would be issued on the conversion of EUR1.25b worth of bonds issued in 2009.  If the bonds are converted, your NPAT increases by the after tax impact of the coupons you would have otherwise paid (7.25% on EUR1.25b - or ~EUR90.6m), ie - you no longer have to pay the bondholders, so profit goes up.

So now we have adjusted NPAT of $1,893m with 1,611m shares on issue - you are at $1.18, and this assumes there is no tax impact on the bond coupons.  I haven't read it in enough detail, but I am assuming coupons are classified as interest expense.  This is not always the case, sometimes they are paid as dividends, which complicates things further.  There may be some other small adjustments to get to $1.19, such as the impact of unwinding derivative positions they have entered to cover the conversion in 2014.

With big businesses like this, the answer always seems to get a bit complicated!

Hope this helps.


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## Klogg (19 July 2012)

yonobarn said:


> Hi again viciam
> 
> You picked a tough one to cut your teeth on!
> 
> ...




Hah, I just looked into it further and failed - couldn't get the same Diluted EPS.

Luckily someone understands it, haha. Thanks Yonobarn.


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## viciam (19 July 2012)

Thank you Yonobarn for working that out, you are awesome.

How did you figure this out? How did you know the answer lay in the Aperam spin off. I wouldn't even have known where to begin looking for the answer and that makes me feel 

and it still doesn't make much sense to me

How long did it take for you to become good at this?

You said you were a stockbroker, can I ask what you do now?


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## yonobarn (20 July 2012)

Glad I was able to help viciam,

If you look at the base of the P&L, it shows the split between EPS from continuing operations, then the EPS from discontinued.  Then it is just a matter of working out what the discontinued ops are.

There are plenty of things that can swing your diluted EPS figures around.  I remember back pre-GFC some of our spreadsheets would have lines and lines of dilutive options that we would track.  Each change in the share price changes the dilutionary impact of the options on issue, and the diluted EPS changes (admittedly usally only slightly, but not always).  Nowadays options are not such a big issue, but no doubt they will make a comeback in the next bull market!

The reason we did it is to make sure we fully understand all of the key levers that may change EPS going forward.  You have already learned now that comparing AM's FY13 EPS with its FY10 EPS is not going to be apples and apples...  Each 'statistic' has its limitations, and fundamental analysis is more art than science...

As for how to make sense of it all (as simply as possible):

 Basic EPS is a measure of the actual, realised accounting figures for the year.  How much profit was actually made (including all one-offs etc), what was the actual weighted average number of shares on issue required to generate those earnings.

Diluted EPS gives you a better figure for comparison in future years - by adjusting by the likely (as at balance date anyway) addition of new shares, and the removal of (some) non-recurring earnings.

Adjusted EPS is the figure most analysts focus on.  This is more subjective, and each analyst tends to have their own style of what earnings they include and exclude.  Should the one-off costs associated with closure of a manufacturing facility be included, or be 'stripped out'.  Buffett's quote about not counting putts on a golf course sits at one end of the spectrum, and existing management's views tend to sit at the other end.
Suffice it to say, reading analyst's EPS numbers should not be taken as gospel.  This is one edge the pros have over the retail punters, ie - they get to talk to the analysts and understand how they produced their numbers.

It will take a long time to 'become good' at it.  I have the analysis of a few thousand sets of financial statements under my belt, hundreds of meetings with company management and fund managers, not to mention countless hours of study (eg CFA course).

However...  Being good at doing the numbers is only a fraction of the game.  It is very important, but like each particular stat, you need to understand the limitations of 'knowing the numbers'.  You can have the best accounting/analytical skills in the world and still lose plenty of money.  

What is going to affect NPAT this year?  Next year?  How is the capital structure likely to change?  What will be the impact of acquisitions?  Do you believe that management know what they are doing?  It has been very hard not to make big bucks in coal over the last decade, is the next decade going to be the same? (FWIW - I reckon the answer is NO!).  This is where you can add real value to your analysis.

As for me nowadays, I read a few of Nassim Nicholas Taleb's books, and decided to get out of the "charlatan profession" of equity analysis.  After seeing first hand why most fund managers cannot beat the index, I set about coming up with a better way and am now involved in a very small funds management operation and trade my own money full time.  No equities whatsoever (what does that tell you?!), equity futures only (it's a far more efficient way to invest) and a big focus on getting the timing right (this is where true outperformance comes from).  Buy and hold is dead - for the time being anyway!!!


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## viciam (20 July 2012)

Thanks for the in depth reply Yonobarn, its very helpful.

Can you shed some light on intrinsic value? What steps should I take in order to get better at putting a value on a company so I can by good companies at the right price. 

Thank you


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## yonobarn (20 July 2012)

We all have a personal style, for me it hinges on things like the quality of earnings (a subjective measure), consistency of earnings, quality of management (you would be surprised at how inept some senior executives are), financial strength (capital structure/leverage), sensitivity to macro themes, industry themes and strategic position within an industry.  Only after you understand each of these can you begin to get comfortable with putting a price on the EPS or NTA you calculate from financial statements.

If you are just starting out, the best free advice IMO is found right here:
http://www.berkshirehathaway.com/letters/letters.html

A few weekends rattling through those and you should be ahead of the average punter!


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## viciam (21 July 2012)

yonobarn said:


> We all have a personal style, for me it hinges on things like the quality of earnings (a subjective measure), consistency of earnings, quality of management (you would be surprised at how inept some senior executives are), financial strength (capital structure/leverage), sensitivity to macro themes, industry themes and strategic position within an industry.  Only after you understand each of these can you begin to get comfortable with putting a price on the EPS or NTA you calculate from financial statements.
> 
> If you are just starting out, the best free advice IMO is found right here:
> http://www.berkshirehathaway.com/letters/letters.html
> ...




I don't want to be an average punter, I want to be an excellent investor. Thanks for the link I will continue reading through those.

I'm reading about ratios at the moment and I have a question. Few different websites will give a slightly different formula for the same ratio. I understand that some analysts will personalize a formula by adding or leaving certain numbers from the balance sheet or income statement out. Is this something only experience can teach? Knowing what could possibly be left out or added to give a more accurate answer? 

I'm looking at Return on Capital Invested and there are examples of EBIT / Capital Employed or Net Income / Capital Employed. Then even Capital Employed is defined differently, some say Capital Employed is Total Assets - Current Liabilities whilst another will say Capital Employed is Average Debt Liabilities + Average Shareholders Equity. 

Is the variations in formulas just a personal preference? How can one know the preferences of top investors? I suppose its down to being flexible and adaptable to the variation of the formula one should use under certain circumstances? Knowing when to use which comes with experience, am I right or am I off the mark?

Thanks again


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## yonobarn (21 July 2012)

Yep, as you gain experience you will become better at knowing implicitly which figures to use.

Ask yourself what a particular ratio is trying to tell you about a company.  A "return on capital invested" figure can tell you a couple of different things.  You need to understand a company's balance sheet, and how they got it to where it is to understand this figure properly.  

For an example, in Australia we have a financial institution called Suncorp (ASX:SUN) that purchased a large general insurance business just before the GFC.  It paid a peak multiple on peak cyclical earnings, issuing a significant amount of new equity at the time to do it.  The value of this acquisition sits at its historical cost in Suncorp's balance sheet (unless they ever write it down), and given earnings have fallen, detracts from its "return on capital invested".

At the other end of the spectrum, you may have a conservative IT company like Technology One (ASX:TNE) that has essentially been run as a private company (ie - minimise tax by expensing as many costs as possible rather than capitalising them).  This keeps the balance sheet small, and "returns on capital invested" high.  If TNE ever goes and acquires a peer, your calculation for ROCI would likely fall.

To further complicate things (!), you need to understand what returns a company can be expected to generate on a marginal dollar of capital invested (this figure is arguably of more value than the vanilla stat, but difficult to quantify).  Sometimes companies don't 'need' as much capital as they have, so they would be best served returning it to shareholders.

The point I am trying to get across is you shouldn't get too hung up on ratios like these, rather you should understand what they tell you, and their inherent limitations.  There is usually limited value in making your ratios 'more accurate', ie - it is unlikely to help you make more money.

May I suggest a good one to start with is EV/EBIT.  

The numerator EV is _Enterprise Value_, and is calculated as market capitalisation (number of shares on issue x current share price) + net debt (long term debt + short term debt - cash).  This reflects the price you as a minority shareholder will have to pay for the "capital employed" and also gets rid of the nuances surrounding a firm's equity figure as reported on its balance sheet.

The denominator EBIT is usually quite easy to calculate (pretax profit plus net interest expense if it is not reported explicitly).  

The value in an EV/EBIT multiple is it normalises out the impact of a firm's capital structure.  That is, it is total earnings before any money is distributed to debt or equity holders.  I would argue that the inverse of your EV/EBIT multiple is probably a more useful proxy for return on capital invested than the others you mentioned.

As always, there is always a few ifs and buts.  In the case of an EV/EBIT multiple, banks do not have them (a lot of their earnings come from net interest received, so you are better served using a PE ratio).  Also, do you want to know average EV for a financial period, the EV at the balance date, etc, etc.  For some businesses an EBITDA figure is of more use, especially those that have big depreciation bills and little capital expenditure requirements.   You may see a theme emerging?

_The *biggest* limitation is that by looking at these figures, you are investing by looking in the rear view mirror, that is, watching stuff that has already happened.  The 'top investors' you refer to are probably more interested in all the factors that will affect the EV/EBIT multiple investors will be willing to pay 3 years from now, and what that implies for the price being paid for shares today!_


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## viciam (24 July 2012)

That's just the problem you see.  I shouldn't get hung up on ratios but rather understand what they tell me and their limitations. But I feel I need to master calculating ratios because if I don't then my calculations will be way of the mark, then when I do try to understand what they are telling me, I will be seeing a picture that isn't accurate.

I'm feeling the emotions of buying stocks though for the first time today since my 2 month history. All of my stocks went down today because of a news that Spain might need sovereign bailout. But I'm trying to keep calm and emotionless because I read somewhere that don't let daily news and plunges in the stock market make you lose your logical thinking to emotional thinking. 

To me it seems things are just going to get worse. The way the worlds economies are shaped up to be and the way the financial structure appears to be showing cracks and China and US at each others throats. You know history tells us that when tension rises too much, a war needs to happen and blood needs to be split in order for things to calm down again, to settle the greed, to get rid of bad feeling. With all the armed conflicts around the world, this euro zone crisis really makes me think I bought these stocks too early because things are going to get worse. The Eurozone countries can't come out of the mess they are in, more loans is not going to solve the problem because it just brings more debt. I get the feeling Eurozone will break up, Its not possible to manage so many different countries under one. I wish I had a crystal ball!


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## viciam (24 July 2012)

I'm very confused


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## craft (24 July 2012)

viciam said:


> I'm very confused




Viciam

Reading your posts in this thread, I feel that you might be placing the cart before the horse.  The accounting will not provide you the answers until you know the questions you are trying to answer.

For example if you want to know the level of profitability of a business it is much easier to drop out the financial structure and look at EBIT/Funds employed then muck around with diluted earnings/debt levels etc to get a meaningful ROE at the per share level.

Get yourself an investing frame work (ie competitive/economic advantage, how durable, how much capital can be applied to it? etc) and you will know what you want the books to tell you and you’ll find it easier to narrow down the areas you need to concentrate on.


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## viciam (24 July 2012)

craft said:


> Viciam
> 
> Reading your posts in this thread, I feel that you might be placing the cart before the horse.  The accounting will not provide you the answers until you know the questions you are trying to answer.
> 
> ...




Hi Craft, that's good advice especially the last paragraph, please elaborate I'd like to hear more

Thanks


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## viciam (24 July 2012)

I think electric cars are the future

Just taking a stroll around my neighbourhood and I can't help but notice electric cars in run down neighbourhoods  meaning its taken the interest of the working class ( largest group of people in any country ). Then large supermarkets and stores like Tesco, Sainsburys and IKEA and NCP car parks are setting up electric charging points in their car parks. Plus there's government incentives for buying electric cars, even the world famous Ford Transit van is coming in an electric version.

Most of the batteries used in electric cars are lithium and so I am now turning my attention to Lithium producing or mining companies. Bolivia has the largest reserves of Lithium with no production as of yet whilst Chile has the 2nd largest reserve with the highest production.

And even if the world economy and Eurozone keeps going down and all hell breaks loose on a global scale, I think lithium will either be steady or grow because of its varied use in military, everyday tech from Iphones to laptops to a growing electric car industry, and if there is all hell and the world doest take a step back because everyone just blows the **** out of each other, as humans we still strive for technology and electricity is always going to remain and lithium is the ultimate electricity storage material on earth. And if all hell doesn't break lose and things improve then that's even better, so that's got my confusion solved a little I think. Not being able to predict the future of the financial collapse or war ( War really can't be dis regarded because its a very real threat, just take a step back and think about it for a second and you may get a feeling that everything is set up for some kind of major conflict, The eurozone collapse, the power shift from US to China, the US isn't going to give up power that easily, infact I remember reading a while back that some official US military doctrine mentioned something along the lines of how the US will do everything in its power to stop another nation rising beyond America. And an economical war is already under way as seen by the trade wars with import tarrifs etc being put into place by US on Chinese goods ) Anyway not being able to predict the outcome of the future I think I'll stick with certain energy and natural resources, in case of hell breaking loose or a gradual economic recovery they will be the winners


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## viciam (24 July 2012)

but saying all that I don't even know where to begin to put a value on a company 

I wish I was einstein, newton, buffett, templeton, aristotle, plato rolled into one then I'd be able to make a good decision


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## burglar (24 July 2012)

burglar said:


> ...
> If the share price rises dramatically, do you sell or hold?
> If it falls, do you buy more?
> ...!!




Do you have a plan?


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## viciam (26 March 2013)

Just re-read this thread, so helpful.

At the time I started the thread, most of the things mentioned were complete jargon to me. Now having spent time learning and teaching myself, looking back and reading this thread makes a lot more sense. 

Some great advice in here! 

Thanks guys


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