Share Buy back and Earning per share EPS-Part I

In my previous article, I had given An introduction to corporate actions, and how it affects the share price.

In this article, I’ll quote a live example of how companies use corporate actions or corporate restructuring to gain benefit and goof up the financial figures.

Really increasing revenue, sales and earnings is not the only way for corporate to show profitable figures. Smart kind of capital structuring can work wonders. Share buyback is one such excellent way of making a nice, healthy and profitable balance sheet, as illustrated in the following example:

When most of us talk about midcap or smallcap growth stocks, we talk about relatively young companies with new products or services that are growing at a fast rate, typically 20% to 25% per year or higher. This figure is available in the balance sheet and quarterly reports and is reported under the EPS or earnings per share.

This value of EPS, typically indicates how much income has each share made. EPS is widely followed in the industry, not only by researchers but also by individuals to track the performance of the company. How can this figure be manipulated?

Let’s discuss a case here: There is a company called Utah Medical products and is listed in NASDAQ. It is in the business of making Medical Instruments. For the past 5 years ending in year 2002, this company has been growing at a staggering rate of 20% per annum. The share price has increased from $7.5 to a high of 18.5$ which is more than 150% profit. How can a company continuously maintain such track record?

One way is to make real profits. Another way is to take advantages of corporate restructuring and corporate actions. Utah Medical Products used a combination of both – mainly of the latter.

The revenues of Utah MP did not grow much. From a high of $42 million in 1997 to $27 million in 2001, the revenues have actually come down. Yet, the earnings per share have increased from $0.5 to a high of $1.15, which is almost 125% increase in the period 1997-2001.

This high value of EPS was from smart Share Repurchase or share buyback plan. How does it work? In simple terms, a company invests money into projects and earns profit. This profit is a certain amount – may be in millions of dollars. This total amount of money is then divided by the total no. of shares, to calculate Earnings per Share or EPS. The reason why EPS becomes important and highly common factor for analysis is because it simply tells you how much each share of a company is earning. This gives a good parameter to judge companies and select between 2 shares. If you want to select between IBM or Microsoft shares, EPS can be a decisive factor.

Continue to Part II of this article