Archive for February, 2011
Math for EPS Growth – Earnings Growth or Share Shrinkage
One important aspect of outstanding shares which I think many people miss is a simple math problem.
What is better for earnings per share…10% earnings growth, or 10% reduction in outstanding shares?
The answer the buy back. The reason why, when you calculate the percentage, you use the original amount for the denominator, so when the amount is decreasing you get different results then when it is increasing.
What sparked this question was building the model for MSFT earnings. With the large amount of stock they are buying back, I wanted to see how this would affect earnings per share. My basic thought was if they grow earnings 10% and buy back 10% of the outstanding shares (actual will be less than this 5-10%), then EPS grow at 20%. Well this is not true, if you do the math, it is actually over 22%. Maybe 2% is not much to you, but if they keep at this pace, and the amount of buy back grows, this difference becomes larger and larger.
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