Earnings per share: a metric that is easy to improve without improving the business

Earnings per share is the net profit attributable to one ordinary share outstanding. This fraction has a numerator and a denominator, and management can move both without changing how the business works. The denominator is reduced through a buyback; the numerator is lifted by non-recurring items — the sale of an asset, a revaluation, a release of provisions, foreign exchange differences. That is why rising earnings per share do not in themselves prove that a company has started earning more: before celebrating the trend, you need to understand which part of the fraction changed and why.

The denominator: shares can be taken out of the calculation

A buyback is the most direct way to improve the metric. A joint-stock company acquires its own shares (Article 72 of the law "On Joint-Stock Companies"), they land on its balance sheet and drop out of the earnings per share calculation. The profit is the same, the divisor is smaller — the metric is higher.

From here the path forks. If the repurchased shares are cancelled, the charter capital shrinks and the effect is locked in. If they stay on the balance sheet as treasury shares, or pass to a subsidiary and become quasi-treasury shares, a discrepancy arises: in consolidated statements such shares are usually excluded from the calculation, yet legally they remain issued and can return to the market. In that case the improvement in the metric is reversible.

The mechanics of the calculation matter too. The number of shares is taken as a weighted average for the period, not as of the reporting date. A buyback carried out towards the end of a quarter will barely affect the current statements and will show up in the following periods — a mismatch that sometimes makes the trend in the metric look ragged without any events in the business at all.

The opposite movement also happens: a new share issue and a secondary offering increase the denominator and dilute earnings per share, even when the money raised goes to sensible purposes. The effect of the investment will come later; the dilution comes immediately.

The numerator: profit that never existed in operations

Net profit is the result of a long chain. Gross profit reflects the economics of sales, operating profit reflects the performance of the core business, profit before tax already includes financial and other items, and only then does net profit appear. Earnings per share are calculated from the bottom line, that is, from the noisiest line of all.

What goes into this noise: income from the sale of a subsidiary or real estate, the revaluation of assets and financial investments, foreign exchange differences on foreign currency debt, the release of provisions created earlier, deferred tax effects. Much of this is unrealised profit, that is, a paper result with no movement of cash. It is for such cases that normalised profit exists: profit stripped of non-recurring items. The difference between ordinary and normalised profit is precisely the measure of how far the metric can be trusted.

Retained earnings — the accumulated result of previous years — stand apart. Their growth does not improve earnings per share for the current period, but it shows what the company is able to pay dividends from and fund a buyback with.

Diluted earnings per share: a second version of the same fraction

Financial statements usually also disclose diluted earnings per share — a calculation that assumes all instruments capable of turning into shares have done so: management options, convertible bonds, obligations under incentive programmes. The gap between the basic and diluted figures shows how much future profit has already been promised to someone other than the current shareholders. If the gap is noticeable and widening, part of the growth in the metric is passing you by.

Why the absolute value cannot be compared across issuers

Earnings per share depend on how many parts the capital is divided into. A share split mechanically lowers the metric, a reverse split raises it — while the value of the business does not change. So comparing the figures of two different companies is meaningless: what is compared is the trend of a single company and derived ratios in which price is set against earnings. The market multiple for {{instrument:SBER}} is 3,77; it rests on the same profit and inherits all its distortions, so a non-recurring item in the statements makes the arithmetic "cheap", not the business.

The metric also has a deeper limitation: it says nothing about how much capital was needed to earn this profit. That part is covered by return on equity — and it has a trap of its own, built in a similar way: the breakdown of ROE shows how a reduction in equity improves the ratio without improving the business.

The order of checks

Step 1. Compare the change in net profit with the change in the weighted average number of shares. If profit is standing still while the metric has risen, the cause lies in the denominator.

Step 2. Find in the statements the lines for other income and expenses, revaluations, foreign exchange differences and asset disposals. Estimate what would be left without them.

Step 3. Reconcile profit with cash flow from operating activities. A discrepancy that persists from period to period is a sign that the profit lives in accruals, not in cash.

Step 4. Look at the gap between basic and diluted earnings per share and at the notes on incentive programmes.

Step 5. Check which standards the figures were prepared under. Consolidated statements under IFRS and statements under RAS give different results, and the dividend base of many Russian issuers is tied specifically to RAS — this explains why a good consolidated profit does not always turn into a payout.

The primary sources for all the steps are issuers' financial statements and the corporate events calendar, which shows when a buyback, a new share issue or a split was announced. Take the earnings per share figure for a specific security from its own statements: it is a calculated value, and disclosure methodology differs between issuers. What a company does with what it has earned is covered in the dividends section; the nearest payouts: {{dividend_calendar|limit=5}}. For the composition of ordinary and preferred issues, see the list of shares, and definitions of related terms are collected in the glossary.

When the metric does work after all

Earnings per share are useful where they are taken not as a valuation but as a link: they translate the result of the whole company into a quantity that relates to your stake. If profit is growing on the back of operations, the number of shares is not being reduced artificially, non-recurring items are few, and cash flow confirms the accruals — growth in the metric means exactly what it appears to mean. All other cases are a reason to read the notes, not the chart.