1 hicorp, inc. a study of earnings per share bloomington group jeff attwood, jean baird, susan...
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Hicorp, Inc.A Study of Earnings Per Share
Bloomington GroupJeff Attwood, Jean Baird, Susan Krieger,
Kent Miller, Terry Nichols, Randy Short
September 22, 2000
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Objectives
Earnings Per Share Terry Nichols– Definitions– Concept and Value– Calculations
Hicorp, Inc. Kent Miller– Case Study Analysis
Valuation, Criticisms and SummaryJeff Attwood
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Concept of Earnings per Share (EPS)
What is Earnings per Share?– Net income available to common
shareholders prior to receipt of common dividends and after dividends to preferred stockholders on a per share basis.
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Basic EPS
Net Income available for common shareholders Weighted average common shares outstanding
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Value of EPS
Assess Profitability– Current– Trends
Assist in Valuation
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Diluted Earnings per Share
Required calculation by publicly held companies Shows a conservative (reduced) number for EPS Measures potential impact on basic EPS of following
instruments:– Convertible preferred stock– Convertible debentures– Warrants – Options
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Diluted EPS
Net income available to common shareholders + Income effect of conversion Weighted average common shares outstanding + Dilutive potential common shares
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Diluted Earnings per Share
What you need to know– Control number
• If positive . . . Calculate diluted EPS• If negative . . . No calculation needed
(Antidilutive)
– Exercise price of instrument• “In the money”• “Out of the money”
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Income Effect of Conversions
Numerator Convertible bonds
– Add back interest expense net of tax
Convertible preferred stock– Add back preferred dividends
Stock options– Add back related compensation expense net of tax
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Dilutive Potential Common Shares
Denominator Convertible Bonds and Convertible Preferred
Stock– Add the amount of additional shares had the
conversion taken place
Stock Options and Warrants
– Add the net additional shares added if proceeds were used to buy back shares at average market price
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Example of Option Inclusion inDiluted EPS Market price of stock = $50
Common shares outstanding 1000
Exercise price of option = $40Option shares = 70In the money? YESAdditional Common Shares issued + 70Common shares outstanding 1070
Company buys back 56 shares with proceeds ($2800/$50) - 56Common shares outstanding 1014
Calculate diluted EPS with 1014 common shares outstanding
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Hicorp, Inc. – Calculations and Excel Worksheet
You can follow the Hicorp calculations on the Excel
spreadsheet located on the Virtual Classroom
Accounting website!
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Consider if . . .
Stock price averaged $95 in 4th Quarter 3rd Quarter net income before changes was negative Extended useful life of equipment from 20 to 30 years Less profitable but purchased stock in open market
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Additional Considerationson Valuation
Price/Earnings Ratio
1 + Growth Rate in EarningsDesired Rate of Return by Equity Investors – Growth Rate in Earnings
Differing opinions on– Growth rate in earnings– Desired rate of return
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P/E Calculation
Stock Price = $33 Diluted EPS = $1.50
P/E = 22 Overvalued?
Fair Valued? Undervalued?
Investor A desires 15% return and forecasts 10% earnings growth Target P/E is 22 (1+.1)/(.15-.1) = 22 FAIR VALUED!
Investor B desires 15% return and forecasts 8% earnings growth Target P/E is 15.4 (1+.08)/(.15-.08) = 15.4 OVERVALUED!
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Criticisms
Amount of assets or capital required to generate EPS Comparing EPS
– Different industries, different risks, different customers . . . Shares outstanding misrepresent capital in use
– Companies may “manipulate the denominator” Smoothing effect of weighted average shares Exclusion of “out of the money” instruments Assumption of buy back on option/warrant exercise Use of control number Other earnings manipulations
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Summary
Earnings per share . . . – Helps assess profitability– Assists in valuation– Has its drawbacks!
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Questions??