Thursday, August 6, 2009

Profit Growth versus EPS growth

Sales up 15%. Profit up 20%.

I am sure you have seen a lot of advertisements over the last few days which look fairly similar. So where is the gap in this storyline? Does all this profit growth necessarily translate into EPS growth? The answer is no and that’s where we miss the wood for the trees.

There is a lot of equity dilution that is happening out there in the marketplace. All these QIP’s / GDR’s that the markets are applauding, ultimately lead to equity dilution. A lot of FCCB’s are getting repriced post negotiations to current market prices which are leading to substantially larger equity dilutions.

Preferential allotments are happening to promoter groups at substantially lower prices because of depressed stock prices over the last six months. And of course there is always Esops which expand the equity base.

The devil as they say is always in the details and in this case the EPS numbers.

9 comments:

Daniel M. Ryan said...

Yes, dilution can be a real EPS killer. Think of how much Citigroup's net income will have to rise to get its EPS back to levels of five years ago.

sajanvm said...

Ninad

One question which has nagged me for a long time:
What difference does EPS make to a business owner ? Does it have any bearing on intrinsic value ?


Rgds

Ninad Kunder said...

Hi Daniel

You are right and markets tend to ignore this variable. It looks very nice to read to headline news which talks about profit growth without understanding how much equity dilution has happenned or how ROE has got affected by the equity infusion.

Cheers

Ninad

Ninad Kunder said...

Hi Sajan

EPS is the starting point for the business owner. You own a fraction of the business by your shareholding. Even if profits go up your % share of the profits go down because now u own lesser % of the business if there is equity dilution.

EPS doesnt have a bearning on the intrinsic value of the whole business but definitely has a bearning on the intrinsic value on a per share basis. Ultimately a business could be worth a billion doallars but what is of value is how much do i own of that.

Cheers

Ninad

sajanvm said...

Ninad
As a business owner, I can only 'pull out' money from the business from the cash flow. So, whatever the business as Net Profit, does not really matter unless it mirrors cash flow ?
Thats the dilemma I am grappling with.

Rgds
Sajan

VISHNU said...

Hi,

If Preferential allotments are done at price higher than the intrinsic value , then it MIGHT be value accretive to the existing moinority shareholders..Ex: Real Estate companies in India often does preferential allotments ..(sometimes higher than intrinsic values.)

Though its a good way to infuse capital into the company, they often abuse minority shareholders.(Note: Some of warren buffet's investments are made this way)

Rather than looking at EPS as standalone number, it is better to look how management is reporting EPS and what their intention behind..(High / low depreciation , Revenue Recognition , Salary Increase / Decrease , Interest Charges , Raw Material Charges , Divdend Payout)

Regards
Vishnu

satheesh said...

hai vishnu from ur message i want you to further explain how can we know the intention of the managment from the parameters u said.Please i am a novice u can even mail me at sathriyan@gmail.com.Expecting ur reply.Even if the blog author replies i will be very glad

VISHNU said...

Hi Satheesh,

I usually tell a joke "A guy's salary is somewhere lies between the number he tells to his mother in law and the number he tells to income tax officer"
To put it in simple terms, assume the Income report (and Balance sheet / Cash flow) is wrong..and start doing your homework from the this point..

For more details , read chapter 1 and chapter 3 of the book "Financial Statement analysis - by Martin Fridson / Fernando Alarez"

Thanks
Vishnu

Ninad Kunder said...

Hi Vishnu

It goes without saying that not just the profit / EPS is important but the quality of it is important.

The objective of the post was different. A lot of the green shoots are driven by capital infusion which though is cleaning up balance sheets ( real estate for ex) is leading to dilution at the EPS level. So the companies could be in a better shape but not the shareholders.

Cheers

Ninad