Understanding the Pitfalls of Per Share Data – EPS Manipulation

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Since I shared on how one can utilise quarterly data to predict if a company's Fiscal Year performance is on target , I also wanted to take this chance to add a important point on how a company can manipulate EPS and PE ratio, or Per Share data for that matter.

EPS and P/E ratio can be changed when a company engages in Share buy-backs. Now, share buy-backs are not necessarily a bad thing, as it increases the per share value that belongs to the shareholder, however, one should be wary that it does not necessarily represent true growth of the company.

How EPS manipulation happen?

When a company engages in buying back their own shares, it reduces the outstanding shares of the company. The net effect is that the PE ratio will look cheap.

 

Let's begin by understanding how EPS and P/E Ratio work:

Formula of EPS = Earnings/Total Outstanding Shares

Formula of P/E ratio= Current Share Price/EPS

 

An Example:

Earnings = $25m

Total Outstanding Shares = 10m

EPS = $25m/10m = $2.5

Share Price = $50

P/E Ratio = $50/$2.5 = 20x

 

Corporate action : Company buys 5m of its own share back, result in total outstanding 5m.

 

Effects of this action using the above example:

Earnings = $25m

Total Outstanding Shares = 5m

EPS = $25m/5m = $5

Share Price = $50

P/E Ratio = $50/$5 = 10x

 

When the number of outstanding shares fall, it increases the eps. This in turn improves the P/E ratio.

This gives the share price a certain degree of support or even push the share price up. One thing for sure, the P/E ratio will look cheap.

 

So ask yourself, does it make sense to you if the company is buying back at this price? Is there a better use for the cash they have on hand, or are they trying to improve the ratio to make it look attractive?

Remember to do your own due diligence before putting your hard-earned money into any company.

 

By Lim Yuancheng

Mentor

Value Investing College

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