Earnings Per Share (EPS)

It has been quite a few days that I posted here. I was actually not able to decide where to start.After due diligence, I decided to start with the most basic of the fundamental tools: THE EPS a.k.a. Earnings per Share.


Why is EPS so Important

While evaluating two companies, one needs to compare the companies on a common basis. We can't compare them on the basis of their market price as that changes daily and also doesn't represent the total worth of a company. Consider company A having only 100 shares of Rs 10000 each and company B with 10000 shares of Rs 1000 each. Obviously, Company B is the bigger one in size!

Similarly, comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Using the raw numbers ignores the fact that the two companies undoubtedly have a different number of outstanding shares. For example, companies A and B both earn Rs 100, but company A has 10 shares outstanding, while company B has 50 shares outstanding.

EPS comes for your help here! In the above example, Company A has an EPS of 10 as compared to 2 for Company B, making Company A as more profitable for the stock holder. So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some ratios (My next Post). Today, we would only concentrate on EPS.

Definition

The portion of a company's profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company's profitability.

Calculated as:

There are 3 kinds of EPS:

• Trailing EPS – last year’s numbers and the only actual EPS
• Current EPS – this year’s numbers, which are still projections
• Forward EPS – future numbers, which are obviously projections

Diluted EPS


expands on basic EPS by including the shares of convertibles or warrants outstanding in the outstanding shares number. This is because all of these can be converted into shares at a particular date. This reduces the EPS value making the stock look more expensive.


In most cases, the diluted earnings-per-share figure is far more accurate estimation of the total earnings per share and receive special attention when valuing a company.


Hope this helps. Do let us know your feedback through comments. If you liked this post and want to receive regular updates, you can subscribe via email.

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Evaluating Shares

We will try to understand few of the key methods to find out if a company is worth investing or not. With the number of companies in the market today, it is really tough to figure out which is worth investing. This is a time consuming exercise but if followed, it can provide rich dividends.

There are mainly 2 ways of selecting stocks.

1. Fundamental Analysis - This is to know how good is a company and to invest in it for a long term. Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security.
2. Technical Analysis - This follows the price variations of a stock and lets you know if the stock has any short term gains. Technical analysis maintains that all information is reflected already in the stock price. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors' emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the 'value' of a stock is. Their price predictions are only extrapolations from historical price patterns.

We will discuss about the Fundamental Analysis today.

Fundamental analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. When analyzing a stock, futures contract, or currency using fundamental analysis there are two basic approaches one can use; bottom up analysis and top down analysis. The term is used to distinguish such analysis from other types of investment analysis, such as quantitative analysis and technical analysis.

Fundamental analysis is performed on historical and present data, but with the goal of making financial forecasts. There are several possible objectives:

• to conduct a company stock valuation and predict its probable price evolution, 
• to make a projection on its business performance, 
• to evaluate its management and make internal business decisions, 
• to calculate its credit risk. 

Even if you don’t plan to do in-depth fundamental analysis yourself, it will help you follow stocks more closely if you understand the key ratios and terms. The main idea behind Fundamental Analysis is Earnings of a company. 

Earnings are profits. It may be complicated to calculate, but that’s what buying a company is about. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend.

When earnings fall short, the market may hammer the stock. Every quarter, companies report earnings. Analysts follow major companies closely and if they fall short of projected earnings, sound the alarm.

But only earnings are not enough to know if the company is worth investing. There are a number of fundamental analysis tools (read financial ratios), that we would discuss in the next few posts.

Keep checking this space for updates!

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What is Face value and book value?

Past few posts we have been metioning this word (face value) a lot. So, what is face value? How is it different from the market value of the share? Why do we need this? How does it matter to me as a share holder? We will try to answer some of these in this post.

Face Value

By the definition of it, Face value is the value of a coin, stamp or paper money, as printed on the coin, stamp or bill itself by the minting authority. While the face value usually refers to the true value of the coin, stamp or bill in question (as with circulation coins) it can sometimes be largely symbolic, as is often the case with bullion coins. For example, a one troy ounce (31 g) American Gold Eagle bullion coin was worth and used to sell for about $670 USD at current market prices (as of July 17, 2006) and yet had a face value of only $50 USD.

For a share this is decided by the company issuing it, at the time of initial offering .It is mentioned on the face of share, Bond certificate or other financial instrument. Face value has nothing to do with market value of the share. Market value of shares changes depending on several conditions. Face value changes only when splitting takes place.

Let me use an example. Suppose,  you want to start a Company with the Capital of Rs. 1,00,000. Now, to arrange this money you take help from  friends and relatives. In exchange, you issue shares of your company, it can be 100 shares, each of the Face Value of Rs. 1,000; or 1,000 shares of Rs. 100 each any such value.

Now let us bring in other value, the Book Value.

Book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities

Suppose your company grows 10 times in a given period of time, and it is worth Rs. 10,00,000. The price of the share of your Company will also grow 10 times, i.e. the book value of a share of the face value of Rs. 10 will become Rs. 100. In case of a loss on the other hand, if your company is  worth only Rs. 10,000, the book value of the share of face value Rs. 10 will become Re.1 only. The Shares are first valued on their Book Value and then by the future prospects or risks involved. If the future prospects are good, I will buy a share (issued by you for Rs. 10 FV, now at Rs. 100 BV) for Rs. 120 or Rs 280 (market value). This will depend on the Market, at what price the holder of the share in your company, is willing to sell. And, suppose, your Company is making losses, I will not buy the share of FV Rs. 10, now available at Re. 1, even if the holder agrees to sell at Re. 0.40. And that is the reason why the shares of different companies sell at different prices.

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Results of the Poll

Hello Readers!!!


Time for the results of the poll we've been running for the past one month. The poll was to see what should we post more on? There were 21 votes in total. The results are as follows:

• Financial Literacy (Accounting) 5 (23%)
• Insurance 1 (4%)
• Investments (Mutual Funds, Stocks) 11 (52%)
• Taxation 4 (19%)

For your information, we have already started posting on Investments. This would be more of a fundamental basics series. Please see Investments on the blog.


Thanks a lot for your responses and showing interest. Keep watching this space for more information. You can also subscribe to us on email, to recieve updates regularly.

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Did your company just Split Shares?

Thought to do a separate post on share splits after getting a lot of comments/questions on this. see comments at http://taxingsalaried.blogspot.com/2009/10/what-is-bonus-share.html.So here is a humble try to explain what a share split is.




What is a share split


When a company splits its shares, it agrees to issue additional shares to the existing share holders, but it doesn't intend to issue new shares like in a Follow-on Public Offer. The shares would come from the existing shares only and hence the face-value of the existing shares would be reduced. For example, if a stock has a face value of Rs 10, a two-for-one stock split will mean that there will be twice the number of shares as before with a face value of Rs 5 each for the new share. So if an investor owns 100 shares, he will have 200 shares after the split. In case of a five-for-one split, there will be five times the number of shares and the investor will own 500 shares for every 100 shares.


Fair enough, but how is this different from a bonus share


As discussed in the other post, in case of a bonus share, the current market price of the share decreases and the face value remains constant, where as in case of share split, both change. 


These 2 are inherently different in terms of accounting. A bonus reduces a company's reserves, converts it into equity capital and then issues additional shares from it. In absolute rupee terms, the equity capital (number of share multiplied by the face value) rises after a bonus. After a 1:1 bonus, the equity capital will double.
In a split, the absolute rupee capital is maintained at the same level and the reserves remain as before.


Merits of such an action

• To make the share price affordable for more people to buy them in open market.
• Increase in liquidity. It is now more readily available in the market to be traded.

What does it change


Practically nothing! A share split or a bonus changes nothing on the fundamentals of the company. It is much like cutting a 12 inches pizza into 8 pieces instead of 4. But investors love stock splits and bonuses. Empirical studies in the US do suggest that stock splits improve prices in most cases as investor sentiment improves. Bonus issues in India have also provided returns to investors.


Analysts do feel that both bonus and stock split indicate the management's conviction to sustain a higher profit growth to service the higher number of shares.

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Recession Over???

The last one and a half year has been like hell for every one. The economy of the entire world slowed down drastically forcing organizations to cut jobs and sending the economy in a downward spiral.


Some of the most common questions these days are: Is recession coming to and end? Is economy showing an improvement? Has the employment rate recovered? Recession is generally described as "a period of economic decline". Lets find out some signs which show that recession is coming to an end.

• A survey of 44 professional forecasters released by the National Association for Business Economics USA, also known as the NABE, found that 80 percent of the respondents believed the economy was growing again after four straight quarters of declines. 
• The latest government data on Monday showed the economy growing by 6.1% year-on-year during the first quarter (April-June) of the fiscal the fastest for any quarter since the global financial crisis began almost a year ago making officials expect 6.5% growth this year making India the second-fastest growing major economy after China, which notched almost an 8% growth rate. More importantly, it's an improvement over the 5.8% notched up by India in the previous quarter and 5.3% recorded in the quarter before that. see this video: 

• FIIs are coming back!

Let's hope these signs result in an end to the recession.

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Dividend Explained...

To carry on what we started with "what is a bonus share?", let's discuss dividends today.

Definition of Dividend

That part of the earnings of a corporation that is distributed to its shareholders; usually paid quarterly. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend.

What's in it for me (WIIFM)?

When a company offers a dividend to its stock holders, it is taking money that could be reinvested into the company, and distributing it to shareholders as a benefit of investing in the company. Receiving a dividend is good for investors, because they get a guaranteed return on their investment in the form of the money from the dividend. A stock that returns a dividend is good as an income investment or a long term growth investment. This is because these stocks tend to remain stable, and offer a tangible monetary benefit to investors.

Dividends are usually settled on a cash basis, as a payment from the company to the shareholder. They can take other forms, such as store credits (common among retail consumers' cooperatives) and shares in the company (either newly-created shares or existing shares bought in the market.) Further, many public companies offer dividend reinvestment plans, which automatically use the cash dividend to purchase additional shares for the shareholder.

How does it work?

Dividend generally comprise of 3 factors:

• Amount - the money that you are getting as dividend from a company. This is generally represented as a percentage of the face value of the share of the company. For example, Hawkins Cooker recently offered a dividend of 200% i.e. Rs 20 per share (face value being Rs 10).
  
• Consistency - How often does a company offer dividends. As dividends are not guaranteed. It depends on the company if it wants to declare a dividend or wants to use the profits for some other purposes. A company that offers dividends consistently along with business growth is usually better as it is able to strike a balance between growth and share holder value.
  
• Timing - This is when would the dividend come into effect. Usually termed as Record Date, this is when all the shares held by any one would be considered for dividend. The point to note is, the shares should be with you before this date. One day after this date the share is termed as ex-dividend.

The other side of the coin

High dividends is not always a sign of good management. A company that needs to reinvest should not pay out all of its accounting profits in dividends. This will cause the productive capacity of the company to diminish and the company to eventually fall into bankruptcy. This actually is a technique of "corporate vultures". They buy a large controlling position in a fine company and purposefully pay far more dividends than they should. This causes the competitive position and productive capacity of the company to falter. This all takes a long time to happen and the company can rest on its laurels for a while. It takes outside analysts a long time to figure all this out. Accounting rules offer lots of scope to obscure what's going on The company is usually able to borrow money to pay dividends for quite a while before the market refuses to offer more credit. Then the inevitable day of reckoning eventually comes, but the "vulture" has already picked the bones clean before the death throes arrive.

The moral of the story is that it "pays dividends" to analyze the dividend record and dividend policy of a company.

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Homeowners in US still have several unanswered mortgage questions

The mortgage market in USA is still fragile and although the government introduced a series of mortgage bailout programs, not all homeowners benefited from the program. It seems that homeowners are still confused about the eligibility criteria of availing Obama’s Mortgage Bailout Program and there are numerous mortgage questions that have still not been answered.

Homeowners are utterly confused as far as the eligibility criteria are concerned. The Making Home Affordable program was expected to help as many as 7 to 9 million homeowners. However, there were many limitations and it was observed that if the program benefited borrowers with primary mortgages, it failed to address the needs of borrowers with secondary mortgages.

Owing to the confusion homeowners had in their mind and due to numerous answered mortgage questions, it did not benefit all homeowners equally. The government’s mortgage bailout program could to some extent make the monthly mortgage payments of homeowners affordable but it failed to attend to the woes of the homeowners that are underwater.

There are many borrowers that are still taking out mortgages with the hope of fulfilling their dream of having a home of their own. And this is the best time to take out a mortgage as the mortgage rates are still low. So, financial experts say that this is a buyer’s market and you should make the best use of the lower rates.

Of late it has been observed that there are many homeowners that are choosing to walk away from their homes voluntarily. This came as a surprise but homeowners that are underwater or the value of their property is at least 15% to 20% less than their mortgage balance are strategically defaulting on their mortgages. This is being referred to as strategic default on mortgages. These homeowners are of the opinion that they don’t want to waste their good money on property that no longer is an asset.

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5 investing lessons from the T20 loss

There can be quite a few similarities between Cricket and Investments. Let us see what we, as investors, can learn from this:

1. Past perfect, future tense
In the T20 format, it is far more difficult to predict than in other longer formats. In the equity markets too, the shorter the time duration, the more difficult it is to predict. Just as how no fund manager knew at 21,000 sensex that the market can come down to 9,000, even those who claimed that they could predict, could never have predicted that from 8,700 market will move up 80 per cent in such a short time.

Lesson: Don't time the market. Invest regularly in a disciplined manner .

2. Strategy matters
Mahendra Singh Dhoni in 2007 was playing to win. In the year 2009 he was playing 'not to lose'. This made him very defensive.

Moreover, the top batsman had a limitation, they could not play the rising ball in England. The bowlers were not effective either.

Anil Kumble, Sachin Tendulkar were all available in England. The selection was poor.

Strategic mistakes in investing include
- too many funds
- choosing sectoral funds
- paying income tax on equity funds (by choosing a balance fund with 50% equity)
- not doing a SIP (systematic investment plan)
- investing a debt for a long term
- not taking adequate life insurance, etc.

These strategic mistakes hurt in the long run.

Lesson: Stick to the investing basics. Read about that here .

3. Never reward mistakes
Most actions are judged on outcomes, not on efforts. When Joginder singh was given the ball to bowl the last over there was no logic, but the result was stunning. So we called Dhoni a strategist. Now selecting Jadeja resulted in a loss. So we call him a failure.

Fund managers who sat on cash from 21,000 to 10,000 looked smart. That was a mistake we lauded. We called their performance as a ‘1st quartile performance’. However, when they sat on cash at 8,700 index waiting for the index to go to 6,500, they lost out. So the same heroes look like zeros!

Lesson: If you made a mistake, accept it and don't repeat it. It may have worked once but not always.

4. Overconfidence kills
Main causes of India’s failure were overconfidence, too many changes in the team, and playing defensive cricket.

Most retail investors struggle about which fund to keep and which to remove. The very simple thing to do is choose one fund and monitor progress. Also the need to transact is so high for the retail investor, that it hurts.

The same hurt you even while investing. Overconfidence (my techniques of last year will work this year), too many transactions, and keeping all your money in debt funds for 20 years.

Lesson: Be patient while investing.

5. Sharpen your skills
Even if you are a good tree cutter you need to take time to sharpen the axe. If you do not take time to think, rest, relax the muscles, how will you recover to play again? We over did our playing. What was the reason that we had a jaded team? Not sure. Many mutual funds tend to relax and rest on their past laurels. Look at their recent performance - it is really jaded!

Lesson: Keep learning

[source: moneycontrol]

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What is a Bonus Share

Reliance Industries has declared a Bonus issue of 1:1. WoW!!! But what does it mean? How does it affect me? Should I purchase RIL shares now?

We will try to get answers to these questions today.

What is a Bonus?

Free shares of stock given to current shareholders, based upon the number of shares that a shareholder owns. While this stock action increases the number of shares owned, it does not increase the total value. This is due to the fact that since the total number of shares increases, the ratio of number of shares held to number of shares outstanding remains constant.

Where did this bonus come from?

Bonus shares are issued by cashing in on the free reserves of the company. 

A company builds up its cash reserve by retaining part of its profit over the years (the part that is not used over the years to expand the capacity, pay the dividend etc.). After a while, this reserve increases, and the company wanting to issue bonus shares converts part of the reserve into capital.

So, the existing investor gets some free shares and the company's profit as well remains in-tact.

Affect of Bonus issue

A bonus issue adds to the total number of shares in the market.

Taking the case of RIL, the company has about 1,642.5 million shares outstanding. Now, with a bonus issue of 1:1, there will be another 1,642.5 million shares added. So now, there will be 3285 million shares.

This is referred to as a dilution in equity.

Now the earnings of the company will have to be divided by that many more shares.

Earnings Per Share = Net Profit/ Number of Shares

Since the profits remain the same but the number of shares has increased, the EPS will decline.

Theoretically, the stock price should also decrease proportionately to the number of new shares. But, in reality, it may not happen.

That's because:

1. The stock is now more liquid. Now that there are so many more shares, it is easier to buy and sell.
2. A bonus issue is a signal that the company is in a position to service its larger equity. That means, the management would not have given these shares if it were not confident of being able to increase its profits and distribute dividends on all these shares in the future.

When does it take effect?

When a bonus issue is announced, the company also announces a record date for the issue. The record date is the date on which the bonus takes effect, and shareholders on that date are entitled to the bonus.

After the announcement of the bonus but before the record date, the shares are referred to as cum-bonus. After the record date, when the bonus has been given effect, the shares become ex-bonus.

Then how is this different from a share split?

In case of bonus shares the value of the share decreases proportionate to the number of bonus shares issued. For example, if the company issues bonus shares in ratio of 1:1 and the price of share is 900 , after bonus issue, the corresponding value of the share gets Rs. 450. Genreally company issues this in place of giving dividends. The market captalization doesn't get affected,  becuase if shares double,  the prices is halved.

In case of a split,  the face value of share decreases. Generally the face value of share is 10 Rs. but face value can be higher as well. So, if face value is Rs 10, then the  company can split the share in ratio of 10:1. Now the person holding 100 shares of rs 10 now will hold 1000 shares of Rs 1 each. now shares can be traded more frequently and this will in turn increase the liquidity of the share.

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