How do I calculate Earnings Per Share?
And once I have calculated EPS, how do I analyze EPS?
What are the drivers of the Earnings Per Share performance of a company?
As the term Earnings Per Share suggests, the formula to calculate EPS is fairly simple:
take Net Income (or more officially-sounding the “consolidated net income attributable
to the company”), and divide it by the number of shares (or more officially-sounding the
“weighted-average number of common shares outstanding”).
You take the absolute number of Net Income, which can be positive or negative, and which
can be large or small, and make it “relative” by dividing it by the number of shares.
How much Net Income belongs to each share?
If you visualize this in a pie chart: what’s my share of the total Net Income, versus that
of other shareholders?
1/10th? 1/100th? Or 1 billionth?
That obviously depends on the number of shares outstanding.
Let’s take a real life example of calculating Earnings Per Share for Apple Inc, second quarter
of fiscal year 2020.
The press release states that quarterly earnings per diluted share were $2.55, an increase
of 4% versus the EPS of the prior year.
We will replicate the calculation to verify the $2.55 EPS, and we will analyze what drove
the increase in EPS of 4% versus prior year.
To do this, we turn to the 10-Q filing of quarterly financial results.
Item 1 Financial Statements, more specifically the consolidated statement of operations,
also called the income statement.
Here in the middle is the $2.55 diluted EPS for the quarter, which is the outcome of the
EPS calculation.
The inputs are Net Income in the numerator, and the number of shares in the denominator.
By the way, the diluted number of shares means “as if all convertible securities were exercised”.
The basic number of shares is the number that currently exists, the diluted number of shares
below it is the number that could exist if all convertible securities were exercised
at the earliest point in time: things like stock options, convertible debt, and warrants.
Let’s get the calculator out.
$11.2 billion in Net Income for the quarter, divided by 4.4 billion shares, results in
Earnings Per Share of $2.55.
What about the 4% increase in EPS?
Well that increase of 4% is actually the result of a decrease in Net Income year-over-year
of 3% versus a 6% year-over-year decrease in the number of shares.
The Net Income decreased, but the number of shares decreased faster!
Mathematically speaking, a decrease in the denominator that is bigger than the decrease
in the numerator, causes the result of the calculation (in our case EPS) to increase.
How does the number of shares decrease so dramatically?
In recent years, Apple has spent between $60 billion and $80 billion of cash per year to
buy back shares, equal to or greater than the Free Cash Flow they generate each year!
An interesting calculation to perform is to figure out what the Earnings Per Share would
have been if the number of shares had remained constant.
Out comes the calculator again.
$11.2 billion in Net Income, divided by 4.7 billion shares, would have been $2.39.
That would have been a decrease in EPS of 3%, in line with the Net Income decrease of 3%.
Let’s do the same EPS analysis for a five-year period.
Here’s a 5-year overview of key Apple financial indicators.
From 2015 to 2019, Earnings Per Share increased from $9.22 for a full year to $11.89 for a
full year, a total increase of 29%.
Where does the EPS increase come from?
Well, Net Income increased from $53.4 billion to $55.3 billion, just 3% in total over the
five-year period.
The number of shares dropped from 5.8 billion to 4.6 billion, a decrease of 20%!
So substantially all of the EPS improvement over the five years we are looking at came
from the denominator (the number of shares) rather than the numerator (Net Income).
Let’s calculate EPS at a constant number of shares.
If we divide 2019 Net Income of $55.3 billion by the 2015 number of shares of 5.8 billion,
then the EPS would have been $9.54, instead of the actual $11.89 after the share buyback.
Back to Q2 of fiscal year 2020.
We looked at the change in the number of shares already, let’s now look at the decrease
in Net Income.
What is driving that?
That’s where analyzing EPS turns into understanding and analyzing the income statement!
How did $11.6 billion Net Income last year turn into $11.2 billion Net Income this year?
Let’s retrieve the consolidated income statement.
Net Income is at the bottom.
Current year Net Income is 3% lower than last year’s Net Income.
Which of the items above Net Income is causing that?
Let’s go all the way up.
Revenue actually increased, by 1%.
Gross Margin grew more than revenue, mainly driven by the revenue mix.
Revenue from products, which decreased year-over-year, has a margin of around 30%.
Revenue from services, which increased year-over-year, has a margin of around 65%.
So if the revenue mix improves, Gross Margin can grow quicker than Revenue.
Operating Expenses, consisting of research and development, and selling, general and
administrative expenses, grew by 13% in total, much faster than revenue or gross margin.
This is mainly driven by increases in headcount, and higher spending on marketing and advertising.
As a result of operating expenses growing faster than gross margin, Operating Income
has decreased by 4%, and Net Income by 3%.
In short: nothing overly dramatic happening in the income statement comparison, the decrease
in Net Income is mainly driven by Apple spending now to be even more competitive in the future
by increasing R&D spending 16% year-over-year, and SG&A spending 11% year-over-year.
Hope you enjoyed this discussion of how to calculate and analyze EPS.
I encourage you to replicate the analysis for companies that you are interested in!
Let me know the outcome in the comments below!
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