Lecture 15 - Eanrnings Per Share Flashcards
What is the P/E ratio? And what does it essentially calculate?
The P/E ratio is the ratio of the price per share over the earnings per share (EPS).
It can therefore be interpreted as the number of years of earnings required to recoup the price paid for a share.
A higher P/E ratio =
High growth prospects
What 4 factors influence the P/E ratio?
- Current performance
- The state of the national economy and individual sector
- International developments
- Potential/possible changes in senior management
IAS 33 defines two EPS figures to be disclosed, what are they?
Basic EPS - based on ordinary shares currently in issue.
Diluted EPS - based on ordinary shares currently in issue+potential ordinary shares
What is the calculation for basic EPS?
“Net profit/loss attributable to ordinary shareholders divided by the weighted number of ordinary shares”
In the basic EPS calculation, net profit means…
The consolidated profit/loss for the period after deciding preference dividends.
Give three limitation of using EPS as a measure of performance.
- EPS is based on historical earnings
- EPS doesn’t take into account inflation
- EPS is affected by managements choice of accounting policies
- EPS is affect by the capital structure of a firm
What are bonus issues?
Bonus shares are shares issued to shareholders of a company free of any cost. They’re an alternative to cash dividends and therefore may be issued when the company has proof cash flow and don’t want to upset shareholders.
Bonus issues can also be known as…
Script or scrip issues
The allocation of bonus issues leads to more … in the capital.
Shares and therefore more (share capital).
A bonus issue provides a financial benefit to whom?
Neither the company or the shareholder
What is a share/stock split?
A share/stock split is a corporate action in which a company divides its existing shares into multiple shares in order to boost the liquidity of the shares.
What are the two main resulting effects of a stock split?
- The number of shares increase
2. The total dollar value of the shares remains the same
Why would a firm with a high prices share choose to split a share?
To boost liquidity
What is the accounting treatment for a stock split that occurs part way through the year?
The split is treated as if it happened at the start of the year.
What is the accounting treatment of new shares issues at full market price during the year?
The number of shares available throughout the year needs to be weighted. For example, if a firm had 500 shares available for 9 months of the year and 750 avaliable for the remaining 3 months, we would have to calculate 500 x 9/12 + 750 x 3/12.
What is a buyback?
A buyback is when a company buys its own outstanding shares to reduce the number of shares available on the open market.
A buyback can also be known as…
A share repurchase
What are the 4 main reasons a firm would choose to buyback their outstanding shares?
- To reduce the cost of capital when equity costs more than debt.
- When shares are undervalued.
- To return surplus cash to the shareholders.
- To increase the apparent rate of growth in BEPS.
What is the accounting treatment for BEPS when a firm chas conducted a buyback?
The weighted average of the number of outstanding shares needs to be calculated and then divided by the profit for the year.
What is meant by the term ‘diluted EPS’?
Diluted EPS is a calculation used to gauge the quality of a company’s earnings per share if all convertible securities were exercised.
What is the ‘relationship’ between basic EPS and Diluted EPS?
Diluted EPS will always be lower than basic EPS
What’s the reason as to why the term ‘diluted’ is used in the Diluted EPS term?
Dilute because earnings in the future may be spread over a larger number of shares.
Give some examples of securities that may have a dilutive effect on future earnings.
- convertible securities
- deferred equity
- employee share options
- share warrants
- potential ordinary shares
