Gilead's Earnings Are Not What You Think They Are

| About: Gilead Sciences, (GILD)

Summary

Gilead's earnings per share are higher than most believe.

Gilead's share repurchases are the reason.

Without future growth, Gilead will be able to report $14 in EPS for the current year.

Gilead (NASDAQ:GILD) is a very profitable company, but most investors and even financial analysts misjudge Gilead's true earnings power due to a methodical mistake.

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The calculation

Usually a company's earnings per share are calculated in the following way: One sums up the reported earnings per share numbers for the past four quarters. This is the correct approach (or an almost correct approach) in most cases, but this approach does not reflect changes in a company's share count.

Let's look at an example: When we have a company which earned $2 per share in the first quarter of the last year, $2 per share in the second quarter, $4 per share in the third quarter and $4 per share in the fourth quarter, this would get us to trailing earnings per share of $12. If the share count remained flat over the last year, there is no problem with this calculation.

But if the share count was 1 million in the first two quarters, and 500,000 during the third and fourth quarter, it looks a little different: In that case, the company's net income would have been $2 million in every quarter, or $8 million for the year. Using a year-end share count of 500,000 shares, I believe it would be more appropriate to say that the company's earnings per share were $16 ($8 million divided by 500,000 shares). After all, $16 is each share's portion of the company's net income if the company's net income and its share count remain stable in the future (i.e. if nothing changes, the company will report EPS of $16 for the following year).

I thus believe that it is a better reflection of a company's earning power when we divide the company's trailing net income by the number of shares outstanding at the most recent point in time, as this approach adjusts for changes in the company's share count. This is also why we have to adjust EPS numbers when a company executes a stock split, or a reverse stock split.

Why it matters for Gilead

When we look at Gilead, we see this effect play out, since Gilead's share count is shrinking at a rapid pace (thanks to Gilead's generous stock buybacks).

For Gilead's GAAP earnings, the first approach gets us to GAAP earnings per share of $11.92 (the number you see when you look up Gilead's EPS on most finance websites). The calculation is $2.76 + $2.92 + $3.06 + $3.18 for the past four quarters. When we, however, use the approach I prefer, we get to earnings per share of $13.22 ($18.1 billion in trailing net income divided by 1.37 billion shares outstanding). I believe the latter reflects Gilead's earnings per share in a better way, as the answer to the following question: How much money will Gilead earn per share if its share count and its net income remain at the current level? is $13.22, not $11.92. The difference between the two numbers is rather large (around ten percent) as a result of a drastic change in the number of shares outstanding.

When we look at non-GAAP numbers, the result is similar: The first approach gets us to earnings per share of $12.68 ($2.94 + $3.15 + $3.22 + $3.32), whereas the second approach gets us to $14.01 (Gilead's trailing non-GAAP net income of $19.2 billion divided by a share count of 1.37 million shares). We can say: If Gilead's share count as well as the company's non-GAAP net income do not change over the next year, Gilead will report $14.01 in (non-GAAP) earnings per share for FY2016, a number that most people would be surprised by.

When we account for the fast ramp-up of International HCV sales (especially in Japan), I believe Gilead should be able to earn at least as much money in the current year as it did in 2015. Even without any future share repurchases, Gilead would thus be able to report $14.00 per share in earnings for 2016, which means that Gilead is trading at less than seven times this year's earnings. Putting a moderate nine times earnings multiple on the stock gives us a price target of $126, which represents an upside of roughly 30% from the current level.

Takeaway

Gilead's share repurchase activity leads us to a situation where most investors underrate the company's true earning power. By calculating the company's EPS in a more appropriate way, we see that even without future growth, the company should be able to report $14.00 per share in earnings for the current year, which makes Gilead's shares very cheap (and thus also very attractive) at the current price.

Disclosure: I am/we are long GILD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.