The 2016 Annual Earnings Release season is currently in full bloom as public companies submit their financial filings to the SEC, send out press releases and hold earnings calls with financial analysts to further accentuate their message to the market. All is a-buzz with executives asking their staff, “Where are we at with the numbers?” What numbers exactly are the center of focus? Countless answers to this question can be found somewhere in the text of each company’s earnings releases and MD&A sections of their financial reports, but the real answer to this question is EPS.
Earnings Per Share, or EPS, is calculated by dividing a company’s earnings by the number of shares of stock outstanding at the end of respective reporting period. Additionally, this ratio is probably the one most frequently used by investors in gauging the value of a company’s stock. Investors review EPS trends and targets as part of investment strategy when deciding to buy, hold or sell a company’s stock.
Intuitively, all other factors equal, if a company increases its earnings, its perceived value and market demand increase and the stock price rises. Then, how is it that market trends exist whereby companies with zero or negative earnings growth experience positive EPS growth, and a related rise in stock price? Enter the ‘savvy’ management team who, in times of earnings decline, decide to dip into the denominator of EPS by decreasing the number of shares outstanding vis-a-vi repurchases of company stock from the open market. So, instead of allowing less than strong earnings results to adversely affect the EPS number and stock price, many companies are increasing amounts of their stock repurchases as an offsetting factor. Executives could explain away their stock buyback activity with the objective to maximize shareholder value. Critics could argue that self-interests of executives to maximize their own incentive compensation, as tied to EPS measures or enhanced by higher stock prices, is the real driver behind increases in a company’s stock repurchase activity.
EPS Analysis: Earnings vs. Stock Repurchases
Let’s look at some examples of digging deeper into a company's EPS data for insight on the actual drivers behind the numbers.
The data card above provides some interesting insight into a notable change in 3M’s trend of stock repurchase activity. Mathematically speaking, a company’s EPS Growth cannot exceed its Earning’s Growth unless the number of shares outstanding decreased at the same time. Charting of 3M’s data highlights a sustained shift in stock repurchase behavior in 2011 as the company’s earnings sharply declined. The data reveals an EPS Growth greater than that of EPS Growth and nominal amounts of stock repurchases in the two years prior. Since 2011, though, 3M has kicked up stock repurchases which have effectively resulted in EPS growth at a higher rate that Earnings growth year over year.
Analysis of EPS data for The Travelers Companies, Inc. revealed that the company’s EPS Growth is consistently impacted by the stock repurchase activity each year. Additionally, the chart highlights 2010 with stock repurchase activity seemingly aggressive enough to divert attention from the company’s contraction in earnings growth to a positive level of EPS growth in the same period. Absent deeper analysis of the data, a cursory review of financial highlights for the year may present a different picture of the company’s actual operating results.
All of this leaves us to wonder - did the company’s actual results ‘meet’ the numbers estimated by analysts and expected by the market? How was stock price impacted? How did executive compensation fair with these ‘managed’ EPS results? All good questions to ask and reasons to dig a little deeper.