Wednesday, October 26, 2011

Determining the EPS of a Company

CFA Level 1 - Equity Investments

Similar to a stock market series, a company's expected earnings per share (EPS) can be determined as

Formula 13.10

EPSstock market series
= [(sales)(operating margin) - depreciation - interest]*(1-tax)

Sales = sales per share of the estimated series determined through regression
OM = the operating margin is typically calculated as a percentage of sales
Depreciation = this is determined by either continuing the trend of the current depreciation or focusing on the expected capital expenditures and how that number relates to future dividends.
Interest = interest is determined by outstanding debt and the interest rate on that debt.

The inputs, however, are determined from specific company data.

Example: Calculate the EPS of a company
Assuming the following estimates for a company, sales per share = $50.00, OM = 20%, depreciation of $5.00, interest of $1.00 and a corporate tax rate of 40%, calculate the forecasted EPS of the company?

EPS = [($50.00)(50%) - $5.00 - $1.00](1-0.40) = $11.40 per share

Determining the Earnings Multiplier of a Company
Similar to a stock market series, a company's earnings multiplier can be determined as follows:The price of the stock is simply divided by the earnings per share of the stock as follows:

Formula 13.9 (restated)


Earnings multiplier

Example: Determining a company's earnings multiplier
With Newco's $0.25 dividend payout, an EPS of $1.00, calculate the stock's P/E ratio assuming 10% required return and 5% growth.

P/E ratio = 0.25/1.00 = 5%
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