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Unit 9: Store Finance and Controls

Forma EPS figure (which means that they have adjusted the income to exclude any one time Notes
items as well as some non-cash items like amortization of goodwill or stock option expenses).
The most important thing to look for in the EPS figure is the overall quality of earnings. Make
sure the company is not trying to manipulate their EPS numbers to make it look like they are
more profitable. Also, look at the growth in EPS over the past several quarters/years to understand
how volatile their EPS is, and to see if they are an underachiever or an overachiever. In other
words, have they consistently beaten expectations or are they constantly restating and lowering
their forecasts?
The EPS number that most analysts use is the pro forma EPS. To compute this number, use the
net income that excludes any one-time gains or losses and excludes any non-cash expenses like
stock options or amortization of goodwill. Then divide this number by the number of fully
diluted shares outstanding. Historical EPS figures and forecasts for the next 1–2 years can be
found by visiting free financial sites such as Yahoo Finance (enter the ticker and then click on
“estimates”).
Through fundamental investment research, one can determine their own EPS forecasts and
apply other valuation techniques below.
Price to Earnings (P/E): Now that you have several EPS figures (historical and forecasts), you’ll
be able to look at the most common valuation technique used by analysts, the price to earnings
ratio, or P/E. To compute this figure, take the stock price and divide it by the annual EPS figure.
For example, if the stock is trading at $10 and the EPS is $0.50, the P/E is 20 times. To get a good
feeling of what P/E multiple a stock trades at, be sure to look at the historical and forward ratios.
Historical P/Es are computed by taking the current price divided by the sum of the EPS for the
last four quarters, or for the previous year. You should also look at the historical trends of the
P/E by viewing a chart of its historical P/E over the last several years (you can find on most
finance sites like Yahoo Finance). Specifically you want to find out what range the P/E has
traded in so that you can determine if the current P/E is high or low versus its historical average.
Forward P/Es reflect the future growth of the company into the figure. Forward P/Es are
computed by taking the current stock price divided by the sum of the EPS estimates for the next
four quarters, or for the EPS estimate for next calendar or fiscal year or two.

P/Es change constantly. If there is a large price change in a stock you are watching, or if the
earnings (EPS) estimates change, the ratio is recomputed.
Growth Rate: Valuations rely very heavily on the expected growth rate of a company. One must
look at the historical growth rate of both sales and income to get a feeling for the type of future
growth expected. However, companies are constantly changing, as well as the economy, so
solely using historical growth rates to predict the future is not an acceptable form of valuation.
Instead, they are used as guidelines for what future growth could look like if similar circumstances
are encountered by the company. Calculating the future growth rate requires personal investment
research. This may take form in listening to the company’s quarterly conference call or reading
a press release or other company article that discusses the company’s growth guidance. However,
although companies are in the best position to forecast their own growth, they are far from
accurate, and unforeseen events could cause rapid changes in the economy and in the company’s
industry.

And for any valuation technique, it’s important to look at a range of forecast values. For example,
if the company being valued has been growing earnings between 5 and 10% each year for the
last 5 years, but believes that it will grow 15–20% this year, a more conservative growth rate of
10–15% would be appropriate in valuations. Another example would be for a company that has
been going through restructuring. They may have been growing earnings at 10–15% over the

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