Chapter 4 Profitability Analysis

Criticisms of EPS

• It does not consider the amount of assets or capital required to generate a particular level of earnings.
• Two firms with the same earnings and EPS are not necessarily equally profitable.
• The number of shares of common stock outstanding serves as a poor measure of the amount of capital in use.
• Despite the above criticisms of EPS as a measure of profitability, it remains one of the focal points of announcements and is frequently used valuing firms.

• Chapter: 04

Common-Size Analysis

• Simple way of creating greater comparability across firms and for same firm through time.
• Most frequently utilized in:
• Income statement: by expressing all line items scaled by revenues.
• Balance sheet: by expressing all line items scaled by total assets.
• Common scaling enables figures across firms and across time to be more comparable.

• Chapter: 04

Percentage Change Analysis

• Computes percentage changes in individual line items.
• Can be compared across firms or across time.
• Focus is not on the financial data themselves, but on the changes in individual line items through time.

• Chapter: 04

Alternative Definitions Of Profits

• Analysts use measures of past profitability to forecast the firm’s future profitability.
• These may include:
• Comprehensive Income
• Operating Income, EBIT, EBITDA, and Other Profit Measures
• Segment Profitability
• Pro Forma, Adjusted, or Street Earning

• Chapter: 04

Return On Assets

• Independent of firm’s financing decisions.
• Measures ongoing profitability.
• Unusual or nonrecurring items (such as restructuring charges), may be removed, net of tax.
• Return on Assets is calculated as:

• Chapter: 04