I appreciate the 1YPEG number for taking a look at investments and have been calculating this number for my holdings. It looks like everyone is using the percentage change in earnings per share for this calculation. I have seen some companies manipulate the earnings per share number by taking on debt to buy back shares in an effort to increase earnings per share while the raw earnings numbers are flat or slightly declining. The headline always reads “Record EPS” while digging into the raw numbers reveals the story is not as good as portrayed.
So my question is should we be using the percentage change in TTM EPS or the percentage change in the raw TTM earnings numbers? For most companies, the 1YPEG is not that different when using EPS or raw earnings. However, I like to weed out companies that manipulate the EPS numbers through share buybacks and I think tracking the change in raw sales numbers and raw earnings numbers through the quarters and years is a better way to evaluate the growth of a company.
Any thoughts or opinions on this approach, EPS versus raw earnings? I think this board is savvier than most so I would like to know what you think.
Hi Wiseguy, Why should you penalize companies that make a lot of cash and reward stockholders by buying back shares? Sure that increases earnings PER SHARE. That’s what it’s supposed to do. There are fewer shares to divide the earnings among. I can’t remember EVER encountering a situation such as you mention, where companies are borrowing money for the purpose of buying back shares. It must be incredibly rare.
Yes, you are correct in that it is a rare case but I have come across one company that was taking on debt while buying back shares with flat to declining overall earnings. Sales were declining as well. The headline always read “Record EPS” which I thought was misleading. That is also why I also track the balance sheets of the companies I invest in and stay away from companies with high debt to cash ratios for the most part as I am sure all of you do as well.
And yes, I think it is a great thing when a company buys back shares through the cash it generates. I think this is a shareholder and balance sheet friendly way to increase value for the shareholders. My concern is with the companies that are taking on debt to fund buybacks, especially with the share price at multiyear highs, while sales and earnings are flat to declining.
Thanks for sharing your thoughts and your contributions to this group.
All of which just underscores that 1YPEG is not meant as an isolated, absolute buy/sell signal, but rather as a screening tool that one uses to identify companies for further research. The further research would reveal things like the EPS growing only because of the stock buyback and the borrowing. Note that, if the stock buyback is happening through cash flow, it is a perfectly legitimate growth in EPS.
You might want to take some company that you know fits these criteria and run them through the formula. My guess is that, with flat earnings and EPS only going up through share reduction the earnings growth will be extremely modest and therefore unlikely to produce an exciting 1YPEG in any case.
Yes, you are 100% correct. I agree that the 1YPEG should be just one factor when considering an investment. I have traditionally looked at changes in raw sales and earnings numbers to evaluate a company and did not weight per share ratios as highly as the raw numbers. I wanted to hear what others thought about this approach especially for calculated a 1YPEG.
Most buybacks nowadays are not good news because in most cases a) the shares are far too expensive to entitle management to do so, and therefore a disservice to investors, and b) because they indicate the company is wary of investment - putting the capital to good use to advance the company’s fortunes. Expensive acquisitions, another feature of our times, are also another feature of ill-service to investors.
So share buybacks, 1YPEG, just like everything else has a context. If I’m not mistaking (easily could be) Apple borrowed money to fund share purchases. With over $1B cash on the balance sheet why on earth would they do this? Because the cash was off shore and repatriating it is was much more expensive than borrowing at stupid low interest rates.
So despite what you might think of AAPL as an investment, just as an example I think it would be a big mistake to call this “manipulation” of their EPS. To me it sounds like sound financial judgment and a better way to reward the owners than increasing the dividend (and attendant tax burden).
Share buy-backs are intended to raise EPS by reducing the denominator of the equation. I suppose under some circumstances it could be viewed as manipulative, but for the most part I think it’s a valid method of improving EPS.
And, for context, quicky googling says Apple bought back $90 and their market cap stands at $691B so this would be buying back 11% of their shares. That is enough to move the needle on EPS, but not enough to transform slow or flat growth into rapid growth.
Don’t forget the revenue growth.It is important that there is revenue growth to go with the earnings growth. I would think that revenue growth in the range of earnings growth takes care of a lot of the mischief. Not all, but a lot.
Which brings up the point about knowing management, one of the first steps in investigating management should be looking at management. You want management that believes they are in partnership with shareholders. We had a dust up (on another board) a while back about Tileshop when I read in the annual report that one of the key employees had been arrested for domestic assault. There was a lot of argument that men get arrested on false accusations during divorces. But the next thing was supplier fraud and payoffs. I think they have cleaned house now and they seem to be turning around. which is why I own shares. But really I wish I had stuck with my conviction and sold when I first found the problem. Don’t do business with unsavory people.
You can see TTS and all my holding on my profile.
TMFFlygal
Supernaut
Since the cornerstone of Saul’s method is based upon using non-GAAP earnings, it is even more critical that we trust the management team. They are the ones who write the reports and give us the non-GAAP numbers, along with the ‘story’ as to why those non-GAAP earnings are meaningful. If you can’t trust the management, you can’t trust the numbers. And if you can’t trust the numbers, you cannot, absolutely can not invest in it.
Tiptree, also burned by the shady dude at TTS. Glad he is goooooone!