Earnings and EPS Earnings, EPS (earnings per share) and how they relate to the income statement and balance sheet
Earnings and EPS
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- In the last video we learned a little bit about what an
- income statement would look like for a very kind of
- vanilla company that sells widgets.
- And in this video what I want to do is close the loop and
- see how this relates to what we talked about in the first
- video, in terms of price per share.
- And we'll talk about earnings per share in this case.
- And then also how the income statement relates to the
- balance sheet.
- And I said I would do it in the last video, but then I
- realized I was running out of time.
- And just as a bit of a quick review, and you probably just
- watched that video.
- But just in case you didn't, revenue was literally the
- widgets that I sold.
- Let's say this was for 2008.
- I sold $3 million worth of widgets.
- Cost of goods sold, well that's just the cost of the
- goods sold.
- So let's say I sold 3 million widgets for $1.
- To produce those 3 million widgets for $1, it cost me
- maybe $0.30 a widget, or $0.33 a widget.
- And so I had a total expense or total cost of goods sold of
- $1 million.
- And so the profit from just selling those-- say in that
- case that I just made up-- $3 million worth of widgets was
- $2 million.
- But I have other expenses.
- I can't just put that in my pocket.
- I had marketing, sales, general and administrative.
- And then I was left with $1 million.
- And that's how much operating profit my
- widget company has produced.
- But I'm not done yet.
- We learned in the last video I didn't
- own the company outright.
- I had some debt.
- In this case, $5 million worth of debt.
- So I have to pay some interest. There was 10%
- interest. So you take the interest out.
- You're left with $500,000 of pre-tax income.
- And of course you have to pay the government.
- And we can debate on whether we're paying them too much or
- too little.
- But they're providing me defense so that other foreign
- countries can't come and bomb my factories.
- And they're providing, hopefully, an educated
- workforce for me.
- And nice roads and infrastructure and
- So who knows?
- So that's what I'm paying for, arguably.
- And so I'm left with net income of $350,000.
- And when people talk about earnings of a company, this is
- what they're talking about.
- Net income is also earnings.
- So when someone says, Google made $4 billion this past
- quarter-- and quarter just means a quarter of a year, a
- three month period.
- And they normally are literally March, June,
- September and December.
- So every fourth of the year.
- They're literally saying, Google made $3
- billion in net income.
- We talked in the first video when we started this series
- about how different companies have
- different numbers of shares.
- So let's make up a number of shares for this company.
- So let's say this company has-- let me do it in mauve--
- so this company's shares, let's say it
- has 1 million shares.
- So you've probably heard not only the term earnings, you've
- probably also heard the term earnings per share.
- So what they do is they just take your earnings number and
- you divide by the number of shares.
- And you have earnings per share.
- Or EPS.
- Sometime people just say EPS for this company in 2008 was,
- and in this case you take $350,000, your total earnings,
- divided by the total number of shares you
- have. And that's what?
- That's $0.35 per share of EPS.
- Before I go into price to earnings and all that, I want
- to connect the dots between the income statement and the
- balance sheet.
- So in this period, I made $350,000.
- So the way you can think about what an income statement is,
- is it tells you what happens between
- balance sheet snapshots.
- So let's say on 12/31/2007, the balance sheet for the
- company would have looked like this.
- Let me just draw it.
- I won't use the square tool.
- So it had $10 million of assets.
- It had $5 million of debt.
- You can kind of view this as the liabilities of which debt
- is one of them.
- Let's just say it's all of it.
- So $5 million of liabilities.
- So the shareholders' equity, or you could almost say the
- book value of the equity of the company, is $5 million.
- $5 million equity.
- And just to kind of tie it a little bit with what we did in
- the first video, if we have a million shares, the book value
- of the equity is $5 million, so if we say the book value
- per share is just going to be this number divided by the
- million shares I have. So $5 million divided by
- 1 million is $5.
- This is the book value for a share.
- Remember, there's a difference between book
- value and market value.
- The stock of this company at 12/31/2007, it could have been
- trading at $10, at $7, at $1.
- That would have been the market value per share.
- This is the book value.
- And the book value is essentially saying, OK, if you
- take the book value of the assets-- and I talked about
- this a little bit in the last video-- but if you say, oh,
- well we paid $10 million, and this is how much value there.
- And I'll go into more detail into how you value
- these types of things.
- And you take out the liabilities, this is what the
- assets are worth according to the accountants.
- The market value could be very different.
- But fair enough.
- I don't want to delve too much into that.
- But now, over this period of time, over 2008, 2008 happens.
- So the rest of 2008 happens.
- And we're left at the end of, let's say 1/1/2009, or we
- could say 12/31/2008.
- It doesn't matter.
- Give or take a day.
- It's a holiday anyway.
- We have a new balance sheet.
- But what happened here?
- Over the course of the year, we earned some money.
- And I won't go too complicated into cash and accrual
- accounting and all that right now.
- We will get into that eventually.
- But I just want to give you the gist of what's happening.
- Is that we made $350,000 in this year.
- So our assets will have increased by $350,000.
- It could have increased by $350,000 of cash.
- It might have been increased by just other people saying
- they owe us $350,000.
- Those are accounts receivables.
- I'll make a whole video, probably a whole series of
- videos, on accounts receivables.
- It's an asset that says, someone owes me that money.
- But any way you think about it, our assets will have
- increased by this amount of money over the
- course of the year.
- So now, our new balance sheet at the end of
- 2008-- so 2008 happened.
- Let me draw 2008.
- 2008 happens.
- At the end of which, our assets would have grown a
- little bit.
- Our assets are now at $10,350,000.
- So I'll put this in thousands.
- This is $10,350 thousands.
- So that's the same thing as $10.35 million.
- And let's see.
- All we did was, we paid the interest on the
- debt in this example.
- We just paid interest. And just so you know, most
- corporate debt actually works that way.
- We'll talk later about amortization schedules and how
- can you pay down the debt.
- But unlike mortgages, a lot of corporate debt, they just pay
- the interest. So we still have the same amount of debt.
- We didn't pay down any of the principal of the debt.
- So we still have $5 million of debt.
- And what's left over for the equity?
- Well all of our earnings, since our
- debt stayed the same.
- All of our earnings actually fall down straight to equity.
- So we have $5,350,000 of equity.
- So the way I think about it, and probably the way you
- should think about it, is the earnings of a company-- in
- this case, we have $350,000 for the year,
- or $0.35 per share.
- They essentially tell you what happened from one balance
- sheet to another.
- So the amount that this number grows by, the amount that our
- equity grows by, is earnings.
- So this is $350,000 of earnings.
- And there's something I might want to touch on.
- Because in the last video I talked a little bit about
- return on asset, where we just took the operating profit, and
- we divide that by the assets.
- We had a 10% return on assets.
- And you might say, oh, well why shouldn't the assets grow
- by that amount?
- And the reason they didn't grow by that amount is because
- we actually ended up having to pay taxes on some of that.
- Even if we had no debt, we would still have to pay taxes.
- This line would have disappeared.
- So sometimes when people talk about return on asset-- which
- I did in that last video-- it might be interesting to say,
- is that the pre-tax or the post-tax return on asset.
- In this example that I did in the previous video, it was the
- pre-tax return on asset.
- But fair enough.
- Balance sheets are just snapshots in time.
- They're kind of like your bank account.
- How much are you worth at any one moment?
- And income statements tell you how do you get from one
- balance sheet to the next balance sheet?
- And we'll learn later the cash flow statement essentially
- reconciles the income statement with what happens
- with your actual cash account, or how things actually move
- within the balance sheet.
- And we'll do that later on.
- But anyway, we started off in this video talking about oh,
- what's cheap?
- What's expensive?
- So the question is, how do you determine that if you can't
- just go by the actual dollar price of-- my baby is crying.
- I should probably run to that.
- Let me do that right now.
- I realize I'm already at 10 minutes.
- I'll see you in the next video.
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