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

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.

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

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,

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

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.

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.

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?

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.

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...

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...

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!

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

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...

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

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?

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.

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.

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.

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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