Equity Research puzzles, solved step by step

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  1. 100A company starts its April to March financial year with 100 crore shares and issues 20 crore new shares on 1 October. Net income for the year is Rs 330 crore. What is EPS?EPS and share countWarm upIndian brokerage researchResearch KPO and GCC

    Try it first

    Which share count goes under the Rs 330 crore?

    Show the worked solution

    Rs 3.00, on 110 crore weighted average shares. The 100 crore opening shares count for the full year. The 20 crore new shares existed only from 1 October, half the year, so they count as 10 crore. Rs 330 crore over 110 crore is Rs 3.00. Dividing by the year-end 120 crore would understate EPS at Rs 2.75.

    Why weight the shares by time?

    A flat shared by two people for six months and three people for the next six has housed two and a half people on average over the year, and splitting the annual electricity bill by three would overcharge the one who arrived late. EPS divides a full year's profit by the shares that were outstanding while it was earned, so shares issued mid-year count only for the part of the year they existed. The money raised on 1 October only helped earn profit in the second half.

    The new shares count only for the half year they existed100 crore for 6 months100 crore still there+20 crore new, 6 months110weighted120100Issue on 1 OctoberAprMayJunJulAugSepOctNovDecJanFebMarEPS = 330 / 110 = Rs 3.00. Using year-end 120 gives Rs 2.75; using 100 gives Rs 3.30.
    The company had 100 crore shares from April to September and 120 crore from October to March, a time-weighted average of 110 crore, so Rs 330 crore of net income gives EPS of Rs 3.00.
    The relationship
    Nˉ=100+20×612=110EPS=330110=3.00\bar N = 100 + 20 \times \frac{6}{12} = 110 \qquad EPS = \frac{330}{110} = 3.00
    N barthe weighted average number of shares, crore
    6/12the share of the year the new shares were outstanding
    330net income for the year, Rs crore
    What it says in wordsCount each share for the fraction of the year it existed, then divide the year's profit by that average.

    When is the time weighting not used?

    When no new money comes in. A bonus issue or a share split changes the number of shares without changing the company's resources, so it is applied to the whole year and to comparative years as if it had always happened. If the 20 crore shares had been a bonus issue, the count would be 120 crore for the full year and EPS Rs 2.75, with last year's EPS restated on the same basis. Confirm the exact treatment against the current accounting standard on earnings per share, Ind AS 33 in India.

    Why does an analyst care about the difference?

    Because next year's EPS starts from 120 crore shares for the full twelve months. If profit stays at Rs 330 crore, EPS falls to Rs 2.75 next year even though nothing got worse, simply because the new shares count for a full year. An analyst forecasting growth in EPS has to model the share count forward, not just the profit, or the forecast will look better than the business.

    Where candidates lose it

    The common slips are dividing by the closing 120 crore, which gives Rs 2.75, or by the opening 100 crore, which gives Rs 3.30. Both ignore when the shares were issued.

    The follow-up catches the rest: candidates who time-weight a bonus issue as if it were a fresh issue for cash have missed the one case where the rule changes.

    What the interviewer asks next

    • The 20 crore shares were a bonus issue instead. What is EPS?
    • If the issue had been on 1 January, what would the weighted count be?
    • What will EPS be next year if net income stays at Rs 330 crore?