Diluted earnings per share

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...

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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!

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!

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

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.

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

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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

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

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?

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?


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.


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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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

viciam said:

...Please be honest and critical as you like

Thanks

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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!

burglar said:

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

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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!!

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.

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

viciam said:

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

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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?

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.

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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?

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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.

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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

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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

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Learn this!

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.

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

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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?

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?

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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

viciam said:

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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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.

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

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

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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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.

yonobarn said:

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

Luckily someone understands it, haha. Thanks Yonobarn.

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?

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!!!

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

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!