Chapter 4 Profitability Analysis



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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:
  • 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

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