RCMA 4: EARNINGS PER SHARE, YIELDS & SHA

Earnings Per Share, Yields & Shareholder Return ---------------------------------------------------------------------------------------------------------------------------------------------

Objectives

Understand the difference between accounting profit versus economic profit, including its definition, calculations, and implications for decision-making in business environments.

Topic Outline

Earnings Per Share
Yield & Shareholder Return
Yield vs. Shareholder Return

Key Definitions

Earnings Per Share (EPS) - Measure shows how much profit is made by a company for each common stock share, this is calculated by dividing the total income after tax with stocks that are still in circulation.
Yield - Shows the expected earnings from an investment in a certain time period, giving an idea of how much return investors or businesses might get under steady circumstances.
Shareholder Return - particularly total shareholder return (TSR), is an indicator that shows the general increase in a stock's price per share along with dividends distributed by the business. It gauges how much benefit investors receive from their investment, considering both capital growth and dividends.

Earnings per share (EPS), yield, and shareholder return are essential financial metrics for investment evaluation, each serving distinct purposes. EPS reflects a company's profitability, yield measures investment return, and shareholder return assesses overall investment performance for the investors.

Earnings Per Share

Earnings per Share (EPS) is a financial ratio calculated by dividing the net earnings available to common shareholders by the average outstanding shares over a specific period. This formula assesses a company's capacity to generate net profits for common shareholders. The higher a company's EPS, the more profitable it is considered to be.

Earnings per share can be calculated through:

EPS = (Net Income - Preferred Dividends)

End of period Shares Outstanding

EPS = (Net Income - Preferred Dividends)

Weighted Average Shares Outstanding

In practice, analysts often use the weighted average shares outstanding to calculate EPS, considering that outstanding shares can fluctuate. The other type of formula is the Adjusted EPS formula which excludes non-core profits and losses, along with minority interests, to focus solely on the profit or loss from core operations on a normalized basis.

EPS Example

ABC Ltd has a net income of $1 million in the third quarter. The company announces dividends of $250,000. The total shares outstanding are at 11,000,000.

The EPS of ABC Ltd. would be:

EPS = ($1,000,000 – $250,000) / 11,000,000

= $0.068

Since every share receives an equal slice of the pie of net income, they would each receive $0.068.

Yield

Yield indicates the amount of money investors make on security within a set timeframe. Typically expressed as a percentage of the security's market value or the initial investment, yield considers the interest and dividends earned from a particular stock or bond.

In most cases, the percentage of the yield relies on factors such as:

Amount invested
Market value
Face value

When using fixed or fluctuating valuations, you can typically classify yield as either known or anticipated. Known yield has a fixed valuation, whereas anticipated yield has a fluctuating valuation.

Net yield is calculated as:

Yield = Net Realized Return

Principal Amount

Yield Example

An investor purchases a stock at $100 per share. After a year the investor has sold the stock for $120 per share. Additionally, the stock pays dividends of $2 per share during the year.

The net yield of the investor would be:

Yield = ($20-$2)

$100

= 0.22 or 22%

Types of Yield

Yields can vary based on the invested security, the duration of investment, and the return amount. Let’s take a look at how to calculate the yield of a few different types of assets.

Dividend Yield

The dividend yield is a financial ratio that tells you the percentage of a company's share price that it pays out in dividends each year.

Dividend Yield = Total Annual Dividend

Stock Price

A stock trades at $67 and pays a quarterly dividend of $0.45.

What is its annual dividend yield?

Dividend Yield = ($0.45+$0.45+$0.45+$0.45)

$67

=$180

$67

=0.02686 or 2.68%

Bond Yield

Bond yield is the return an investor gets from holding a bond, typically shown as a percentage and based on the interest or coupon payments the bond provides over a set period.

Bond Yield = Annual Coupon Payment

Bond Face Value

A bond trades at $300 and pays a $6 coupon twice a year.

What is the bond’s current annual yield?

Bond Yield = (6+6)

300

= 12

300

= 0.04 or 4%

Real Estate Yield

A real estate yield is a measurement of future income on an investment. It is generally calculated annually as a percentage, based on the asset’s cost or market value.

Real Estate Yield = Annual Rent Payment

Rental Property Value

An investor owns a house worth $150,000, and tenants pay them $750 in rent each month. What is the annual yield of the rental property?

Real Estate Yield = $750x12

150,000

= $9,000

150,000

= 0.06 or 6%

Shareholder Return

Total Shareholder Return (TSR) serves as a metric that reflects the stock's performance during a specific holding period. It encompasses both the capital gain from the stock's value appreciation and the dividends received from holding the stock, presented as a percentage.

Total shareholder return is calculated as the total increase in a stock's share price, combined with dividends received, divided by the initial purchase price of the stock, or:

Total Shareholder Return = (Current Price - Purchase Price) + Dividends

Stock Price

Shareholder Return Example

An investor has purchased 100 shares of XYZ company stock at $20 per share. The stock is currently trading at $24 per share. Since the investor bought the stock two years ago, the company has paid out a total of $4.50 in dividends per share.

What is the TSR over those two years?

Total Shareholder Return = [($24-$20)+$4.50)]

= [($24-$20)+$4.50)]

= 8.5

= 0.425 or 42.5%

Drivers of Shareholder Return

Net Income Growth

Net income growth drives Total Shareholder Return (TSR) by signaling company growth and profitability, leading to increased dividends, stock price appreciation, long-term sustainability, and competitive advantage, attracting investors and boosting TSR.

Earnings Per Share (EPS)

Earnings per share, or EPS for short, shows the financial gain a company achieves for every equity share. This comes from the Net Income. If the firm earns more profit, its EPS grows. A higher EPS indicates that the company's profitability is growing significantly.

Price to Earnings (PE)

PE Ratio demonstrates the amount of money investors want to give for a share in the company's earnings. If the company's earnings increase, it means that investors have gained more confidence and trust in future prospects. When PE ratio gets bigger, it indicates that the investors are willing to pay a higher price.

So, net income growth, EPS, and PE ratio are the drivers for Shareholder Return because they contribute to a higher valuation for the company, leading to a higher stock price.

Yield vs. Shareholder Return

The terms "return" and "yield" both describe calculations that show the profits gained from an investment. However, these metrics have distinct differences as they represent varied financial gains associated with investment performance or time frames.

Shareholder Return offers an evaluation of past performance, documenting the earnings an investor has obtained from an investment over a particular time frame. These returns take into consideration:

Past interest
Capital gain
Share price increase
Dividend increase

Alternatively, yields analyze potential future performance. Yields make assumptions about future earnings based on interest rates remaining stable. Yields account for:

Future Income
Future interest earned through an investment

Practice Questions

Part 1: Theories (5)

1. A higher EPS indicates more ____ because investors will pay more for a company with higher _____.

A. Assets, Liabilities.

B. Balance, Income.

C. Income, Shares.

D. Value, Profits.

2. EPS shows how much money a company makes for each _______ of its stock:

A. Share

B. Profit

C. Cost

D. Dividend

3. Which of the following best describes “Yield”,

A. Total revenue generated by the company.

B. The annual rate of return on an investment.

C. The price at which an asset can be bought or sold.

D. Amount of debt a company holds.

4. What does a higher yield typically indicate in the context of investment?

A. Lower risk.

B. Higher liquidity.

C. Lower Returns.

D. Higher Returns

5. What factors can impact shareholder return in the stock market?

A. CEO compensation.

B. Interest rates.

C. Number of employees.

D. Office location.

Part 2: Problem-Solving (5)

Suppose the following information (in millions of dollars) is available for Limited Brands for a recent year:
Sales revenue $9,060
Net income $213
Preferred dividend $0
Weighted-average common shares outstanding 300 million.

Compute the Earnings Per Share for Limited Brands.

A.$0.78

B. $0.71

C. $0.73

D. $0.70

2. Keanu Inc. has a net income of $200,000, average shares of common stock outstanding of 40,000, and preferred dividends of $20,000 that were declared and paid during the period.

What is Keanu Inc.'s earnings per share of common stock?

A. $4.5.

B. $3.5.

C. $3.8.

D. $4.8.

3. Dion's considering investing in a stock, so he wants to determine his annual yield from it. The stock has a share price of $175.50 and pays an annual dividend of $7.20 per share.

What is Dion’s dividend yield?

A. 4.0%

B. 4.1%

C. 4.2%

D. 4.3%

4. Jamie wants to buy a home that he can rent out to earn extra money. He finds a home to purchase for $350,000. After researching the market, he decides to rent it out for $2,200 per month. His monthly fees to maintain the property are $1,050.

What is Jamie’s real estate yield?

A. 4.21%

B. 3.91%

C. 4.10%

D. 3.94%

5. WEW, a company operating in a stable market sector, recently issued a dividend payment of $21 per share to its investors. Additionally, TKQ's current share price is $350 per share, compared to its share price of $310 per share one year ago.
What is the Shareholder return over the period?

A. 17.4%

B. 18.2%

C. 18.9%

D. 19.7%

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Answer Key

Theories

D. Value, Profits

Explanation: When investors observe a company with increased profits, they tend to perceive it as a valuable investment and may be willing to pay more for its shares.

2. A. Share

Explanation: By dividing a company's total earnings by the number of outstanding shares, EPS provides insight into the company's profitability on a per-share basis.

3. B. The annual rate of return on an investment.

Explanation: Yield represents the income return on an investment over a specific period, typically expressed as a percentage. It indicates how much income an investment generates relative to its cost.

4. D. Higher Returns

Explanation: A higher yield suggests that the investment is expected to provide greater returns relative to the amount invested. It implies that the asset has the potential to generate more income or profit for the investor..

5. B. Interest Rates

Explanation: Changes in interest rates can influence borrowing costs for companies, affecting their profitability and investment decisions. This, in turn, can impact stock prices and ultimately shareholder returns.

Problem-Solving

1. B. $0.71

Solution:

Economic Profit:

Earnings Per Share = ($213 - $0)/$300

Earnings per share = $0.71

Therefore, Limited Brands EPS is $0.71.

2. A. $4.5

Solution:

Earnings Per Share = ($200,000 - $20,000)/$40,000

Earnings per share = $4.5

Therefore, Keanu Inc.'s EPS is $4.5.

3. B. 4.1%

Solution:

Dividend Yield = ($7.20/$175.50)

Dividend Yield = 0.041or 4.1%

Therefore, Dion’s Bond Yield would be 4.1%.

4. A. 62,000

Solution:

Annual Rental Income = ($2,200*12)

Annual Rental Income = $26,400

Annual Expenses = ($1,050*12)

Annual Expenses = $12,600

Net Rental Income = ($26,400-$12,600)

Net Rental Income = $13,800

Real Estate Yield = ($13,800/$350,000)

Real Estate Yield = 0.0394 or 3.94%

Therefore, Jamie’s Real Estate Yield is 3.94%.

5. D. 19.7%

Solution:

Total Shareholder Return = [($350-$310)+21]/310

Total Shareholder Return = 0.197 or 19.7%

Therefore, WEW’s Shareholder Return for the period is 19.7%.

References:

Das, A. (2023, June 10). Learn with etmarkets: What is total shareholder return?. The Economic Times. https://economictimes.indiatimes.com/markets/stocks/news/learn-with-etmarkets-what-is-total-shareholder-return/articleshow/100894776.cms?from=mdr

Ganti, A. (2021, May 29). Total shareholder return (TSR): Definition and formula. Investopedia. https://www.investopedia.com/terms/t/tsr.asp

Lee, D. (2023, May 26). What is yield in finance? (and how to calculate it) | indeed.com. https://www.indeed.com/career-advice/career-development/what-is-yield

Indeed Editorial Team. (2023, February 4). Return vs. yield: What’s the difference? (with examples) | indeed.com. https://www.indeed.com/career-advice/career-development/return-vs-yield

Salvucci, J. (2023, September 13). What is yield? definition, calculation, types & examples - thestreet. https://www.thestreet.com/dictionary/yield