My precious-s-s-s EPS

16 févr. 2023

In the previous post, we began looking at the Income statement that the company publishes for each quarter and year. The report contains important information about different types of profits: gross profit, operating income, pretax income, and net income. Net income can serve both as a source of further investment in the business and as a source of dividend payments to shareholders (of course, if a majority of shareholders vote to pay dividends).

Now let's break down the types of stock on which dividends can be paid. There are only two: preferred stock and common stock. We know from my earlier post that a stock gives you the right to vote at a general meeting of shareholders, the right to receive dividends if the majority voted for them, and the right to part of the bankrupt company's assets if something is left after paying all debts to creditors.
So, this is all about common stock. But sometimes a company, along with its common stock, also issues so-called preferred stock.

What advantages do they have over common stock?
- They give priority rights to receive dividends. That is, if shareholders have decided to pay dividends, the owners of preferred shares must receive dividends, but the owners of common shares may be deprived because of the same decision of the shareholders.
- The company may provide for a fixed amount of dividend on preferred shares. That is, if the decision was made to pay a dividend, preferred stockholders will receive the fixed dividend that the company established when it issued the shares.
- If the company goes bankrupt, the assets that remain after the debts are paid are distributed to the preferred shareholders first, and then to the common shareholders.

In exchange for these privileges, the owners of such shares do not have the right to vote at the general meeting of shareholders. It should be said that preferred shares are not often issued, but they do exist in some companies. The specific rights of shareholders of preferred shares are prescribed in the founding documents of the company.

Now back to the income statement. Earlier we looked at the concept of net income. Since most investments are made in common stock, it would be useful to know what net income would remain if dividends were paid on preferred stock (I remind you: this depends on the decision of the majority of common stockholders). To do this, the income statement has the following line item:

- Net income available to common stockholders (Net income available to common stockholders = Net income - Dividends on preferred stock)
When it is calculated, the amount of dividends on preferred stock is subtracted from net income. This is the profit that can be used to pay dividends on common stock. However, shareholders may decide not to pay dividends and use the profits to further develop and grow the company. If they do so, they are acting as true investors.

I recall the investing formula from my earlier post: give something now to get more in the future. And so it is here. Instead of deciding to spend profits on dividends now, shareholders may decide to invest profits in the business and get more dividends in the future.

Earnings per share or EPS is used to understand how much net income there is per share. EPS is calculated very simply. As you can guess, all you have to do is divide the net income for the common stock by its number:
- EPS (Earnings per share = Net income for common stock / Number of common shares issued).

There is an even more accurate measure that I use in my analysis, which is EPS Diluted or Diluted earnings per share:
- EPS Diluted (Diluted earnings per share = Net income for common stock / (Number of common shares issued + Issuer stock options, etc.)).

What does "diluted" earnings mean, and when does it occur?
For example, to incentivize management to work efficiently, company executives may be offered bonuses not in monetary terms, but in shares that the company will issue in the future. In such a case, the staff would be interested in the stock price increase and would put more effort into achieving profit growth. These additional issues are called Employee stock options (or ESO). Because the amount of these stock bonuses is known in advance, we can calculate diluted earnings per share. To do so, we divide the profit not by the current number of common shares already issued, but by the current number plus possible additional issues. Thus, this indicator shows a more accurate earnings-per-share figure, taking into account all dilutive factors.

The value of EPS or EPS Diluted is so significant for investors that if it does not meet their expectations or, on the contrary, exceeds them, the market may experience significant fluctuations in the share price. Therefore, it is always important to keep an eye on the EPS value.

In TradingView the EPS indicator as well as its forecasted value can be seen by clicking on the E button next to the timeline.



We will continue to discuss this topic in the next publication. See you soon!