It can be difficult to determine what a company’s earnings per share (EPS) report means. Management has a variety of ways in which they can potentially manipulate earnings per share numbers in their favor. Investors have to know how to evaluate the quality of any kind of EPS to find out♌ what it's telling them about a stock and to potentially protect themselves.

What Is EPS?

The evaluation of earnings per share should be a relatively straightforward process but it can become a game of smoke and mirrors thanks to the magic of accounting. It can be accompanied by constantly mutating versions. We have GAAP and non-GAAP EPS figures that form💦 the bottom line after some in-dept🌠h considerations on the income statement for direct costs, indirect costs, and EBIT.

Investors will generally get some preview of these expectations through previous guidance, a whisper number, or a consensus point, but the real numbers aꦡre never known until the report is released.

The clouding of EPS reporting can't be entirely blamed on management, however. Wall Street also deserves some blame due to its myopic focus on the near-term and knee-jerk reactions to 1-cent misses. A forecast is always only a guess, nothing more and nothing less, but Wall Street often forgets this. This can create opportunities for investors who can evaluate the quality of earnings over the long run and take advantage of market 澳洲幸运5开奖号码历史查询:overreactions, however.

Calculating EPS

Start with a simple understanding of what EPS♐. This is the bottom line on an in💯come statement that shows a company’s total net income divided by its shares outstanding.

The income statement i💧s typically broken into four parts:

• The company’s direct costs which results in net revenue and gross margin
• Indirect costs which results in operating income, also known as earnings before interest and tax (EBIT), and operating margin
• The net income which is the company’s earnings after subtracting interest and tax from EBIT
• A breakdown of earnings per share

ജThe final portion of the income statement that focuses on earnings pe😼r share breaks out the earnings in two ways.

Public companies report basic earnings per share and 澳洲幸运5开奖号码历史查询:diluted earnings per😼 share. Basic earnings per share is generally the net income divided by the free float or active shares in the market. The diluted earnings per share is the net income divided by the total shares available including free float and converti♉ble shares. Companies and the media usually focus on diluted earnings per share.

The EPS portion of the income statement is also often adjusted based on non-GAAP ⛄measures. A company c🔥an potentially manipulate the EPS number through its management of shares or its adjustments using non-GAAP items.

EPS Quality

A high-quality EPS can mean that the number is a relatively true representation of what the company earned. This will usually come with very few non-GAAP earnings adjustments. It also may involve a company’s earnings recognition strategy. Earnings recognition strategies will vary by industry and company. They can easily be overlooked but they're important to understand when evaluating the quality of EPS.

🦂 Higher expenses, a lot of non-GAAP adjustments, and unnecessary changes in shares outstanding can be flags for low-quality EPS reports. Management can alter shares outstanding through new issuance and buybacks. Accounting standards also provide for latitude in the area of revenue recognition.

Companies must nonetheless be ethical in their ꦇEPS reporting. Working outside of the standards for revenue recognition can lead to management problems and lawsuits such as for Enron and WorldCom.

How to Evaluate EPS

EPS is a byproduct of a company’s earnings so there are a few ways to eval💦uat𝓀e it. Looking at the income statement can be important for understanding the expenses of the company and how those expenses are managed. Gross margin, operating margin, and net margin are all helpful for evaluating expenses at different phases of the income statement.

Use Comparisons

Using comparisons can help evaluate EPS quality. An EPS number in isolation is only the result of a company’s reported revenue minus expenses divided by shares outstanding at any given time. It ♓can therefore be important to look at EPS from different angles.

Some investors break down EPS similar to maওrgins so they can look at net revenue per share or EPS from continuing operations. It can also be important to look at EPS growth and compare EPS across the industry. Th༒ere should be some explanation as to why EPS is spiking or growth is far higher than that of comparable companies.

Look at the Cash Flow Statement

Investors can also 🔥turn to the cash flow statement and operating cash flow in particular for an analysis of earnings quality. Some investors analyze operating cash flow and operating cash flow per share in comparison to EPS. Investors would generally like to see operating cash flow per share higher than EPS.

It can be a flag if a company’s EPS is growing without an increase in operating cash flow or with negative operating cash flow. This can indicate high operating charges po☂ssibly from🔯 unrealized revenue receivables. It may also be the result of high levels of depreciation or amortization over the long term.

Negative operating cash flow may also require a deeper analysis of debt levels, days sales outstanding, and 澳洲幸运5开奖号码历史查询:inventory turnover. Cash is king so it can be a cause for concern if operating cash flow is showing some challenges while earnings aꦆre growing steadily or at a faster pace than in the past.

Trends Are Important

It can be important for investors to look at EPS from different angles. T🥂rends can be an important factor in the analysis.

An entire industry may have increasing or decreasing EPS growth due to macro variables that are affecting the industry as a whole. A company might also be beating or falling behind trends because of new introductions or increased capital expenses. Companies may also be🎐 reporting decreases in pro forma operating cash flow versus future EPS expectations.

A multitude of factors can affect the EPS analysis of a company, an industry, and operating cash flow. A company may have one low or high quarter in some cases due to new strategic investments or idiosyncratic factors. Evaluating trends can help to spot different types of scenarios. There may be legitimate reasons for discrepancies and downtrends such as economic cycles and the need to invest for future growth but problems can't last long if the company is going to survive.

The Bottom Line

A company’s EPS report usually attracts a lot of attention. It provides the bottom-line earnings results forඣ a company and is one of the key measures of performance on a quarterly or annual basis. It attracts a lot of attention so m🅘anagement and investors place a lot of importance on it.

Executives can use a variety of techniques to potentially manipulate EPS in their favor. Investors are subject to this, however, so it can be important for them to have a good unde൩rstanding of what EPS represents and the ways to analyze it to realize the quality of earnings.

Markets are known for being efficient overall and the efficiency of the market usually leads to higher valuations for companies with growing, high-quality earnings and lower valuations for decreasing earnings or earnings of low quality. Management can use certain techniques to adjust EPS in their favor but investors and the market usually won't allow for discrepancies over long periods.

Steadily degrading quality of earnings will often result in activist intervention and/or shareholder lawsuits that seek retribution for ovℱerlooking the best interests of the shareholders in management EPS s💖trategies.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our 澳洲幸运5开奖号码历史查询:warranty and liability disclaimer for more info.