(2)-Share Buy back and Earning per share EPS-Part II

This is part II of the article Share Buy back and Earning per share EPS – Part I. Please start reading this article from the beginning, before proceeding with this part.

So suppose, there are 100 million shares of Utah MP, and are currently trading at 2$ each. So the total value of the company stands at 200 million $. Suppose the company generate an income or earning of 50 million $.

Hence, the EPS of the company becomes = Total Earnings/Total no. of shares

= 50 million/100 million = $ 0.5

Now the company decided to buyback 10 million shares from the investors, at the market price of 2$. So, the investors will be paid a total of 20 million $ and the company will receive 10 million shares from the investors. Hence, the remaining no. of shares will be used to calculate EPS on the same total earnings:

Hence, the EPS of the company becomes = Total Earnings/Total no. of shares

= 50 million/90 million = $ 0.55

This is a clear-cut increase of more than 11% in EPS. Therefore, without actually generating extra earnings or income, the company can still show profitability and increase in EPS year-on-year.

Experienced researchers and equity research teams while looking at EPS also take these factors into consideration, like share buyback or corporate actions. However, we common investors fall victims to such things. If you look for EPS on Google, you will find most of the financial sites mentioning that we should look at past records of continuous growth in EPS year on year. What we fail to realize is how to take into consideration the effects of share buyback and other corporate actions, which are used as effective tools by the companies to make a fool of investors by presenting bloated figures.

Here is the exact data for Utah MP and how it worked:

Year	2001	2000	1999	1998	1997
Shares Outstanding	5210	5978	7197	8273	8495
EPS ($)	1.15	0.9	0.76	0.6	0.5

Over the 5 year period, the company continuously kept on buying back the shares and hence ended up showing a 125% rise in EPS, from 0.5 to 1.15$. Though there was some real growth and a continuous decline in revenue, majority of these figures were bloated because of such schemes of buyback.

As we can observe from the above example, EPS figure may appear to be pretty interesting and effective tool to make a comparison for stock picking or stock selection. However, care should be taken while observing the historical data. One should keep in mind that there may be a big possibility of a corporate action or corporate restructuring, which will result in high values of EPS. As demonstrated above, Utah MP bought back the shares continuously for 5 year period, resulting in a fantastic growth in EPS year on year. People in the accounts department of the company are experts in such tricks. Researchers who are educated know how to adjust the calculations. Individual investors like you and me get trapped with these jazzy numbers. In fact, any data presented on balance sheet or financial results should be looked upon with a doubt, as one figure is derived from the other.

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You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.