Page 148 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 4: Fundamental Analysis

There are various methods employed to assess the future outlook of the revenue, expenses and Notes
the earnings from given the economic and industry outlook. These methods can be broadly
classified into two categories, traditional and modern. Under the traditional approach, the
forecaster obtains the estimate of the single value variable. While in the case of modern approach,
he obtains the range of values with the probability of each. Let us discuss these two approaches
in detail.

Traditional Methods of Forecasting EPS

Under the traditional approach the following methods of forecasting are adopted.
1. ROI approach

2. Market share approach
3. Independent estimates approach
Beginning the discussion on the forecasting techniques, it will not be out of place to briefly
mention that the earnings per share are measured from the financial statement. This will provide
us an understanding of its changes. Broadly, changes in earnings are affected by operating and
financing decisions. Both these decisions are, however, interdependent. Various companies do
this by presenting the information in the income statement reflecting both types of decisions.
Given below is the format, which analyses:
Income Statement for the year ended………..
1. Sales revenue
2. Less interest expenses

3. Earnings before interest and tax (EBIT)
4. Less interest expenses
5. Earnings before tax (EBT)
6. Number of shares outstanding

7. Earning after tax (EAT)
8. Number of shares outstanding
9. EPS = EAT/number of shares outstanding
Let us now explain the ROI approach to forecast earnings per share

ROI Approach

Under this approach, attempts are made to relate the productivity of assets with the earnings.
That is, returns on the total investment (assets) are calculated and estimates regarding per share
are made stated.
Return on Assets = EBIT/Assets
Return on assets is a function of the two important variables viz., turnover of assets, and margin
of profit
Return on Assets = Assets Turnover × Profit Margin

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