Earnings Per Share and Dividend Payout

Question 1

What is Earnings per share (EPS)?

Answer 1

EPS is probably the most heavily relied-upon performance measure used by inventors

EPS states the amount of current-period earnings that can be associated with a single share of a corporation’s common stock

EPS is only calculated for common stock because common stockholders are the residual owners of a corporation. Since preferred shareholders have superior claim to the firm’s earnings, amounts associated with preferred stock must be removed during the calculation of EPS

Question 2

Under what conditions would a firm have a simple capital structure?

Answer 2

A corporation is said to have a simple capital structure if one of the following two conditions applies:

1. The firm has ONLY common stock (i.e. there are no preferred shareholders with a superior claim to earnings in the form of dividends)
2. The firm has NO dilutive potential common stock

Question 3

What is potential common stock (PCS)?

Answer 3

Potential common stock (PCS) is a security or other contract that may entitle the holder to obtain common stock (i.e. convertible securities, stock options and warrants and contingently issuable common stock

Note: Potential common stock is said to be dilutive if its inclusion in the calculation of EPS results in a reduction of EPS

Question 4

What is Basic earnings per share (BEPS)?

Answer 4

BEPS = Income available to common shareholders (IACS) / Weighted-average # of CS outstanding

A firm with a simple capital structure only has to report a single category of EPS = Basic EPS

Two BEPS amount are reported - one using income from continuing operations and one using net income

The numerator (income available to common shareholders) equals the relevant income amount (income from continuing operations or net income) minus dividends on preferred stock

The denominator is determined by weighting the shares for the portion of the reporting period that they were outstanding

Question 5

What is Diluted earnings per share (DEPS)?

Answer 5

DEPS = [Income available to common shareholders (IACS) - Divds on convertible Pref. stock + Convertible debt (after-tax interest)]

/

Weighted-average # of CS outstanding + WA number of add’l shs of CS (would of been outstanding if dilutive potential common stock had been converted)

Note: A firm with preferred stock or dilutive potential common stock must report 2 categories of EPS:

a. Basic EPS
b. Diluted EPS

If EPS is used as part of a ratio calculation (i.e. price-earnings), DEPS should be used if available

Question 6

What are the 3 ratios used to measure the degree of success towards a company goal of increasing shareholder wealth?

Answer 6

Increasing shareholder wealth is the fundamental goal of any corporation. 3 common ratios measure the degree of success toward this goal:

1. Earnings yield ( EPS / Market price per share)
2. Dividend payout ratio ( Divds to CS / IACS or NI)
3. Dividend yield (Divd per share / Market price per share)

Question 7

What is Earnings yield?

Answer 7

Earnings yield is the rate of return on the purchase price of a share of common stock. It is the reciprocal of the P/E ratio and thus measures the amount of earnings an investor expects to receive per dollar invested:

= Earnings per share / Market price per share

The earnings yield can be compared by investors to other types of investments to determine whether a given stock is comparable to other stocks in the industry or to alternative uses of the investment money

Question 8

What is the Dividend payout ratio?

Answer 8

The dividend payout ratio measures what portion of accrual-basis earnings was actually paid out to common shareholders in the form of dividends:

= Dividends to common shareholders / IACS

= Divds / NI per share

Note: Net income per share = EPS

Note: Growth companies tend to have a low payout, preferring to use earnings to continue growing the firm

Question 9

What is the Dividend yield?

Answer 9

Dividend yield = Dividend per share / Market price per share

Various investors have different desires with respect to dividend yield. Historically, many long-term investors wanted a low dividend yield because capital gains were taxed at a lower tax rate than dividends; thus, letting the earnings accumulate within the company resulted in a lower overall tax expense

However, in recent years, the tax rate on dividends has been as low or lower than that on capital gains; thus, a high dividend yield has come into vogue

Investors in different circumstances have different perspectives on dividend yield. For example, a retiree wants regular income and therefore wants to see a high dividend yield. A person who is years away from retirement would prefer a lower dividend yield with the earnings reinvested in the business