Question

You are a research analyst for a publicly traded company, and you’ve been assigned to give a presentation on how a company uses performance metrics in corporate valuation.

Respond to the following in a minimum of 175 words:

• Think about how you would present return on equity (ROE) and earnings per share (EPS) to a group of investors or senior management.
• Explain the use of ROE and EPS in evaluating the value of a company. Include how to calculate ROE and EPS.
• Why is understanding ROE and EPS important to a company’s value?
• Share an example of a company whose ROE and EPS you calculated. What do these results say about the company?

Answer 1

Return on Investment (ROI)

Return on Investment is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI will directly measure the amount of return on a particular investment, relative to the investment’s cost. To calculate ROI, the return of an investment is divided by the cost of the investment. The result is expressed in  percentage or a ratio.

ROI is a famous metric because of its versatility. Essentially, ROI can be used as a tool to find an investment’s profitability. This could be the ROI on a stock investment, the ROI a company expects on expanding a factory, or the ROI generated in a real estate transaction. The calculation is relatively easy to interpret for its wide range of applications. If an investment’s ROI is net positive, it is probably worthwhile. The investors should avoid negative ROIs, which imply a net loss.

Calculation ROI

ROI = Current value of investment - Cost of investment / Cost of investment

Example

Suppose Sachin  invested $1,000 in MRF Corp. in 2017 and sold his stock shares for a total of $1,200 one year later. To calculate his return on his investment, sachin would divide his profits ($2,200 - $2,000 = $200) by the investment cost ($2,000), for a ROI of $200/$2,000, or 10 percent.

With this information, he could compare his investment in Slice MRF with his other projects. Suppose Sachin also invested $2,000 in DSI Inc. in 2014 and sold his shares for a total of $2,800 in 2017.

The ROI on Sachin's holdings in DSI would be $800/$2,000, or 40 percent.

Importance of ROI

• ROI is a profitability ratios. It is one of the easy measures for investors to understand the profitability of their return. Thus, the analysis helps investors and management in comparing various investment opportunities.
• ROI analysis helps to calculate and compare the return of the current and previous periods for better understanding of the portfolio performance.
• Fund managers carry ROI analysis on the portfolios to understand the competitiveness in the market.
• Since ROI analysis is not much complicated, investors do not need much assistance to understand it.
• ROI analysis could also helps in constructing a better or good portfolio by regularly assessing the ROI of different sectors and changing the portfolio mix accordingly.

Earnings per share (EPS)

Earnings per share (EPS) is a company's net profit divided by the number of common shares it has outstanding.EPS indicates how much money a company makes for each share of its stock. It is a widely used metric for corporate profits.A higher EPS indicates more value because investors will pay more for a company with higher profits.EPS can be arrived at in several forms, such as excluding extraordinary items or discontinued operations, or on a diluted basis.

The earnings per share metric is  one of the most important variables in determining a share's price. It is also a major component used to calculate the price-to-earnings (P/E) valuation ratio. By dividing a company's share price by its earnings per share, an investor can see the value of a stock in terms of how much the market is willing to pay for each dollar of earnings.EPS is one of the many indicators you could use to pick a stocks. Comparing EPS in absolute terms may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings. Instead, investors will compare EPS with the share price of the stock to determine the value of earnings and how investors feel about future growth.

Formula of EPS

The earnings per share value are calculated as the net income (also known as profits or earnings) divided by the available shares. The numerator of the equation is also more relevant if it is adjusted for continuing operations.To calculate a company's EPS, the balance sheet and income statement are used to find the period-end number of common shares, dividends paid on preferred stock (if any), and the net income or earnings.

It is more accurate or better to use a weighted average number of common shares over the reporting term because the number of shares can change over period of time.

EPS = Net income - Preffered divident / End of period common shares outstanding or Weighted average shares outstanding

Example

XYZ Ltd has a net income of $2 million in the third quarter. The company announces dividends of $350,000. Total shares outstanding is at 15,000,000.

The EPS of ABC Ltd. would be:

​EPS = ($2,000,000 – $350,000) / 15,000,000
EPS = $0.11

• Types of EPS

1. Basic EPS

2. Diluted EPS

Importance of EPS

1. It measures profitability of the company
2. It is an determinant of P/E ratio
3. It is an indiactor of divident payout
4. It helps investors to make informed decisions
5. It allows investors to compare investments across sectors, industries and to an extent also with alternative investments.
6. It also helps to chart the financial performance of a particular company over time.

ROE vs. EPS

1. The ROE is a better indicator than simple EPS of how a company is deploying its capital to build a profitable business.
2. A company’s ROE should be compared to that of its competitors and other companies in the same sector, whereas EPS and P/E ratios are better used as a gauge of whether the shares themselves are over or undervalued.
3. The higher the ROE, the more wealth the company is creating for its shareholders, and the better return they can expect from their investment.

so all the are the details of ROI and EPS.

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