Earnings per share

Stock-based compensation: Transparency, timing and EPS

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Stock-based compensation can be difficult. Two approaches to measurement, valuation uncertainty, frequent adjustments for changes in estimates (including sometimes the stock price), and a dilutive effect in addition to an expense, all contribute this being a topic many investors try their best to avoid.

Investors are not helped by inadequate stock-based compensation disclosures. Some companies go further than required by accounting standards, such as Swiss bank UBS, whose helpful additional analysis gives more transparency. However, this analysis raises interesting questions about the timing of the expense and the impact on diluted EPS.

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Earnings enhancement, earnings dilution and rights issues

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Although we generally prefer an enterprise value based approach, earnings and price earnings ratios remain an important and legitimate component of equity analysis and valuation. Earnings based analysis includes the earnings per share enhancement or dilutive effects of major transactions.

We discuss the value relevance of earnings enhancement or dilution arising from new capital bring raised and invested, with a focus on rights issues. In an earnings-based approach to analysis, it is important to correctly apply the rights issue adjustment factors to both historical and forecast earnings per share.

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Analysing complex capital structures – perpetual bonds

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Many companies look beyond straight debt and ordinary shares when raising finance, with capital structures increasingly including an array of complex financial instruments. This presents challenges for investors, particularly when analysing performance and leverage.

We investigate the effects of one form of ‘hybrid’ financing – perpetual super-subordinated bonds – where securities with debt-like features may be reported as equity in financial statements. Recent proposals by the IASB to improve transparency in reporting these instruments and other complex capital structures will help investors.

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The diluted EPS calculation is 50 years out of date

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It will soon be the 50th anniversary of the publication of the Black-Scholes model for option valuation. The fair value of options has since been incorporated into several aspects of financial reporting. However, in the case of diluted earnings per share, the accounting still pre-dates Black-Scholes.

The treasury stock method for calculating diluted earnings per share only considers the intrinsic value of written equity options, such as warrants and employee stock options. We explain why this is a problem and the further reasons why the full economic value dilution resulting from these securities is not reflected in financial statements.

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EPS growth: Demergers and special dividends

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Differences in adjustments to the share count related to special dividends and demergers can impair the comparability of earnings per share. Under IFRS, EPS growth depends on whether a stock consolidation accompanies a distribution. However, stock consolidations, by themselves, have no economic impact and should not affect performance metrics.

In Vivendi’s recent distribution of shares in Universal Media Group, the lack of an accompanying stock consolidation resulted in a discontinuity in per share metrics. However, in a similar distribution by GSK, a stock consolidation produced a very different outcome. We explain the problem for investors and how you can adjust to ensure comparability.

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