Financial Columns
   (Originally Appearing in The Motely Fool)

Today's Buzzword: Earnings!
Back to Basics, Part 14

By Vince Hanks

We'll conclude the series on the income statement this week by briefly discussing the one item that gets all the love and attention from the financial publications and broadcasts these days, the darling of quarterly report, earnings per share (EPS).

Publicly traded companies are required each quarter to disclose how much income they earned. Earnings per share is simply the net income for a period, divided by the average number of common shares outstanding for that same period. EPS is the amount of income, on a per-share basis, that a company has at its disposal to invest back into the business or pay out to shareholders as a dividend. When calculating EPS, a company must factor the weighted average number of shares outstanding for the quarter or year. Weighted average means that consideration is afforded to both the number of shares outstanding and the amount of time each share was outstanding. The number of shares during a quarter often change due to new shares being issued or the retirement of shares.

EPS is presented as earnings per common share and is based on after-tax income from continuing operations, plus or minus discontinued operations, extraordinary items, and the cumulative effects of changes in accounting principles. EPS is also net of preferred stock dividends, if any have been issued.

Often you'll hear earnings reported as "pro forma." This simply means that the EPS has relinquished its amateur status and is ready for the major leagues. OK, that's not what it means at all. Pro forma statements describe what would occur if the company had operated in Marvel Comics' "What if?" universe. In other words, earnings showing the projected operating results if certain events or transactions are absent or present. An example of pro forma income might be earnings excluding one-time charges or expenses related to a business acquisition.

Another nuance of EPS reporting that often leads to confusion is the term "fully diluted EPS." Fully diluted means earnings are based on all common stock equivalents being converted into common stock. Common stock equivalents include convertible preferred stock, convertible bonds, and warrants. While fully diluted earnings are lower based on all convertible securities, adjustments are made by adding back interest expense from convertible bonds and dividends for convertible preferred stock to the bottom line. Fully diluted EPS can be very complicated, considering that it factors in the effect of every event as if it had happened.

With EPS, or pretty much any other income statement item, the trend from one period to an equal period year-over-year is crucial when evaluating a company's fiscal health. A company might have very sizable EPS, but if earnings are not growing at a good clip year-to-year, there's a good chance its share price will be similarly stagnant.

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