The P/E ratio is calculated by dividing the Price of the stock by the earnings per share, rather than the Market Cap divided by the earnings per share.

Following your calculations above, the error seems to be in the first line. You write the following equation

P (price) = mkt_cap / shrs;

However you must remember that mkt_cap = price * shares

This equation would then simplify down to P (price) = (price *shrs)/ shrs, and you would be left with price = price.

In step 3, the equation would now be P/E = price / (earnings/shrs), which is the correct equation for P/E.]]>

The P/E ratio is calculated by dividing the Price of the stock by the earnings per share, rather than the Market Cap divided by the earnings per share.

Following your calculations above, the error seems to be in the first line. You write the following equation

P (price) = mkt_cap / shrs;

However you must remember that mkt_cap = price * shares

This equation would then simplify down to P (price) = (price *shrs)/ shrs, and you would be left with price = price.

In step 3, the equation would now be P/E = price / (earnings/shrs), which is the correct equation for P/E.]]>

Share repurchases affect the denominator in EPS, causing EPS to increase. Since EPS increases (the denominator in P/E), P/E decreases.

The pictures in the article provide some examples.]]>

Share repurchases affect the denominator in EPS, causing EPS to increase. Since EPS increases (the denominator in P/E), P/E decreases.

The pictures in the article provide some examples.]]>

I can show you how many people confuse earnings growth with EPS growth.

First, we must both agree that a stock's price (which may be different than "value" to the shareholder) is based on future earnings growth.

When analysts create projections, they model future revenue, depreciation, interest expenses, etc and arrive at future earnings. These earnings are then converted in to an EPS, which is heavily published on many Stock News/Analysis websites. Let’s assume for company X an analyst models earnings of 5M (10% growth) for next year, which translates into a $1 EPS.

If company X goes on to report EPS of $1, did they meet expectations? Is the value the analyst assigned to the stock price correct? The answer is we don't know; however, news agencies will report that EPS has met expectations.

Part of that $1 EPS may be attributed to share repurchases, rather than earnings growth. While those share repurchases may have created value for the shareholder, the analysts model, and subsequently the fair value he/she assigned to the stock, is based on earnings growth.

An article published by McKinsey & Company in 2005 similarly notes that share buybacks, which boost EPS, do not necessarily signify an increase in underlying performance. For them to point this out, they must have also believed it is not as obvious as you may think:

"...making buybacks an alluring substitute if improvements in operational performance are elusive. Yet while the increases in earnings per share that many buybacks deliver help managers hit EPS-based compensation targets, boosting EPS in this way doesn't signify an increase in underlying performance or value"

http://bit.ly/ZudEhd ]]>

I can show you how many people confuse earnings growth with EPS growth.

First, we must both agree that a stock's price (which may be different than "value" to the shareholder) is based on future earnings growth.

When analysts create projections, they model future revenue, depreciation, interest expenses, etc and arrive at future earnings. These earnings are then converted in to an EPS, which is heavily published on many Stock News/Analysis websites. Let’s assume for company X an analyst models earnings of 5M (10% growth) for next year, which translates into a $1 EPS.

If company X goes on to report EPS of $1, did they meet expectations? Is the value the analyst assigned to the stock price correct? The answer is we don't know; however, news agencies will report that EPS has met expectations.

Part of that $1 EPS may be attributed to share repurchases, rather than earnings growth. While those share repurchases may have created value for the shareholder, the analysts model, and subsequently the fair value he/she assigned to the stock, is based on earnings growth.

An article published by McKinsey & Company in 2005 similarly notes that share buybacks, which boost EPS, do not necessarily signify an increase in underlying performance. For them to point this out, they must have also believed it is not as obvious as you may think:

"...making buybacks an alluring substitute if improvements in operational performance are elusive. Yet while the increases in earnings per share that many buybacks deliver help managers hit EPS-based compensation targets, boosting EPS in this way doesn't signify an increase in underlying performance or value"

http://bit.ly/ZudEhd ]]>

Since EPS decreases (the denominator in P/E), P/E increases.]]>

Since EPS decreases (the denominator in P/E), P/E increases.]]>

I never called share repurchases misleading. I made it clear in my conclusion that I am not advocating against them and I believe they are an effective way to increase shareholder value. I am merely cautioning against making year to year comparisons as many news publications and earnings releases do. For example, when referring to earnings, they may say "Company X EPS grew by 10% year over year". I am cautioning that EPS growth does not necessarily equal earnings growth.]]>

I never called share repurchases misleading. I made it clear in my conclusion that I am not advocating against them and I believe they are an effective way to increase shareholder value. I am merely cautioning against making year to year comparisons as many news publications and earnings releases do. For example, when referring to earnings, they may say "Company X EPS grew by 10% year over year". I am cautioning that EPS growth does not necessarily equal earnings growth.]]>

If an investor is doing year to year comparriosns or relative value comparisons, using these ratios, they would not provide an accurate picture, as the ratios have been skewed by the impact of the buybacks.]]>

If an investor is doing year to year comparriosns or relative value comparisons, using these ratios, they would not provide an accurate picture, as the ratios have been skewed by the impact of the buybacks.]]>

In 2011, Coca-Cola had 327 millions shares outstanding. In 2012, 301 million. Coke generated 8,062 million in revenue (sales) during 2012.

The current revenue per share is 8062/301 = 26.8. The revenue per share, assuming they didn’t participate in any buybacks (using 2011 share outstanding numbers) is 8062/301= 24.7.

The price of the stock at the time of writing was 37.67.

To get P/S, we divide the price of the stock by revenue per share. Current P/S would be 37.67/26.8=1.41, and assuming no buybacks 37.67/24.7= 1.53. By participating in the buybacks the ratio is reduced by 8 percent.]]>

In 2011, Coca-Cola had 327 millions shares outstanding. In 2012, 301 million. Coke generated 8,062 million in revenue (sales) during 2012.

The current revenue per share is 8062/301 = 26.8. The revenue per share, assuming they didn’t participate in any buybacks (using 2011 share outstanding numbers) is 8062/301= 24.7.

The price of the stock at the time of writing was 37.67.

To get P/S, we divide the price of the stock by revenue per share. Current P/S would be 37.67/26.8=1.41, and assuming no buybacks 37.67/24.7= 1.53. By participating in the buybacks the ratio is reduced by 8 percent.]]>

Many news publications, and earnings releases, commonly quote EPS and EPS growth. Part of that EPS growth may be attributed to a reduction in shares, rather than a growth in earnings. My advice is to not rely on these publicized numbers and go directly to the financial statements to determine actual earnings growth and to make meaningful comparisons from year to year.]]>

Many news publications, and earnings releases, commonly quote EPS and EPS growth. Part of that EPS growth may be attributed to a reduction in shares, rather than a growth in earnings. My advice is to not rely on these publicized numbers and go directly to the financial statements to determine actual earnings growth and to make meaningful comparisons from year to year.]]>

There are actually a few different ways to calculate Free Cash Flow:

1) EBIT(1 - t ) + Depreciation - Capital Expenditures + or - Net Working Capital

2) Cash Flow from Operations - Capital Expenditures

Using the first method, one would arrive at an unlevered FCF. It would not take into account debt interest or principal repayment (except short term notes payable).

Using the second method, which I used above in my article, partially takes into account debt. To calculate Cash Flow from Operations, we start with Net Income. Net Income takes into account interest payments. For this reason, I prefer this "partial" levered FCF as interest payments are required , prior to paying out dividends.

Finally, if one wants to calculate a true Levered FCF, continuing with method 2, Net Borrowings can be deducted from FCF. This fully levered FCF would take into account the repayment/issuance of debt.

Ultimately, we are trying to determine the cash a company has left over to pay dividends. Method 2 above does a good job at this in that it shows how much cash is left over after regular operations, which would include servicing debt. Since it doesn't take into account debt issuance, there should be no concern that a company is borrowing money for the purpose of funding dividends.]]>

There are actually a few different ways to calculate Free Cash Flow:

1) EBIT(1 - t ) + Depreciation - Capital Expenditures + or - Net Working Capital

2) Cash Flow from Operations - Capital Expenditures

Using the first method, one would arrive at an unlevered FCF. It would not take into account debt interest or principal repayment (except short term notes payable).

Using the second method, which I used above in my article, partially takes into account debt. To calculate Cash Flow from Operations, we start with Net Income. Net Income takes into account interest payments. For this reason, I prefer this "partial" levered FCF as interest payments are required , prior to paying out dividends.

Finally, if one wants to calculate a true Levered FCF, continuing with method 2, Net Borrowings can be deducted from FCF. This fully levered FCF would take into account the repayment/issuance of debt.

Ultimately, we are trying to determine the cash a company has left over to pay dividends. Method 2 above does a good job at this in that it shows how much cash is left over after regular operations, which would include servicing debt. Since it doesn't take into account debt issuance, there should be no concern that a company is borrowing money for the purpose of funding dividends.]]>

FCF is a good metric to determine the amount of cash a company has left over after regular operation. However, certain companies may require additional deductions from FCF to arrive at a more accurate representation of a company’s left over cash. As an example, companies which issue preferred shares. Since cash must be paid out to preferred dividends prior to being paid out to common stock dividends, preferred dividends should be deducted from FCF.]]>

FCF is a good metric to determine the amount of cash a company has left over after regular operation. However, certain companies may require additional deductions from FCF to arrive at a more accurate representation of a company’s left over cash. As an example, companies which issue preferred shares. Since cash must be paid out to preferred dividends prior to being paid out to common stock dividends, preferred dividends should be deducted from FCF.]]>

Unfortunately, the issue I described above seems to affect Finviz as well. Search for Visa (V) on Finviz and you will find that they have the EPS (TTM) listed as 1.87, and thus they calculate the Trailing P/E at 79.49, similar to Google Finance.

If you pull up Visa's latest 10-K, you will see the EPS TTM per diluted share is 3.16. The basic EPS is 3.17, so Finviz//Google Finance are not using that number either.

As I mentioned, Finviz does have a great screener, but if someone was screening for stocks with a P/E of under 50 (as a wild example), Finviz's screener would not pick up Visa, even though it would have qualified.]]>

Unfortunately, the issue I described above seems to affect Finviz as well. Search for Visa (V) on Finviz and you will find that they have the EPS (TTM) listed as 1.87, and thus they calculate the Trailing P/E at 79.49, similar to Google Finance.

If you pull up Visa's latest 10-K, you will see the EPS TTM per diluted share is 3.16. The basic EPS is 3.17, so Finviz//Google Finance are not using that number either.

As I mentioned, Finviz does have a great screener, but if someone was screening for stocks with a P/E of under 50 (as a wild example), Finviz's screener would not pick up Visa, even though it would have qualified.]]>