What’s EPS?
EPS stands for earnings-per-share and represents the total earnings or net income of a company on a per-share basis. It’s a financial metric that can be calculated by dividing a company’s net income by its number of shares outstanding:
Calculating EPS is pretty straightforward: If a company reported a net income of $50 million in the last quarter while having 25 million shares outstanding, the company’s EPS in that quarter would approximately be $2.
The pure meaning of a single EPS figure doesn’t really give any further insights into a company’s performance other than whether it’s profitable or unprofitable. For example, there would be no way to tell whether company A with an EPS of $3 was better or worse than company B that has an EPS of $5. The reason for that is the fact that companies can have different numbers of shares outstanding which directly affect EPS as a metric.
In order to analyze a firm’s earnings-per-share, we would have to attach context to the metric: We could, for instance, look at a company’s history of EPS and calculate its CAGR to assess how a company has performed in the past. Another option would be to put the most recent earnings-per-share in relation to the current stock price with the P/E ratio, which can give us a better picture on a company’s value.
»Learn More About What’s a Good Earnings-per-Share
How Can Companies Have a Negative EPS?
The earnings-per-share is a function of a company’s net income and the number of its outstanding shares. Since a business can’t possibly consist of negative shares, the only reason for a negative EPS are negative earnings.
Negative earnings reflect the company’s unprofitability in the given time period, meaning that the business wasn’t able to generate revenue or income beyond its total operational costs.
What Does a Negative EPS Mean?
A negative earnings-per-share reflects a company’s unprofitability which should clearly not be a positive sign for most investors. Companies with poor financial health, temporary distress, or bad operational efficiency will usually report negative earnings as a consequence of such problems.
However, before jumping to the quick conclusion that the business that you’re analyzing is plainly bad as a result of its negative earnings, it would be worth looking for what exactly has led the business to be unprofitable in the first place.
Some companies can report a negative EPS on a given period due to a substantial one-time expense which distorts the earnings number for the specific time frame.
Many unprofitable businesses are usually still in an early stage within their business lifecycle, where negative earnings are the rule rather than the exception. The reason is that it takes time to establish and grow a working business model until profits can finally be generated. In either way, it would make sense to assess the individual circumstances of any given company first, before labeling it as a bad investment.
In the following, we will go through some approaches that you can take to further assess companies reporting negative earnings-per-share.
How to Analyze Companies With Negative EPS
Assessing the history of the company’s EPS
Evaluating one single EPS figure is mostly not going to give any insights into a company’s performance. If the company’s current earnings-per-share is negative, you could look at past EPS measures to attach a better context to the firm’s performance.
For example, a business that has constantly been generating positive earnings in the past time periods, but suddenly reports negative earnings due to some temporary incident or event, is likely to recover and become profitable again. Another firm that was consistently unprofitable for years as a result of a poor business, will be in a completely different situation even if both currently report negative earnings.
Here is an example of a typical company that reported temporary negative earnings as a result of a one-time event:
Heineken N.V. is a well-known Dutch brewing company. In its fiscal year of 2020, the business reported negative earnings due to the consequences of the global pandemic. As a result, Heineken’s EPS for 2020 was negative -$0,35 which was very odd to see from the world’s second-largest brewer.
By looking at the history of the company’s EPS, you can see that the business has managed to grow its EPS continuously over the past decades which strongly suggests that the company is expected to recover as soon as circumstances revert back to standard conditions.
Heineken already reported two-quarters of positive earnings-per-share this year which should result in a normalized state for the company’s earnings in the fiscal year of 2021.
Using Other Metrics Instead of EPS
Earnings-per-share is only one of the many metrics that can be used to analyze a company’s financial performance. There are several other measures that may be used to assess a firm’s financial performance even if it isn’t profitable:
- Operating Income is also a profitability measure and represents the earnings that a business has generated from its operations. If the net income of a company is negative, chances are that operating income could be positive since non-operational costs such as interest expenses and taxes payments aren’t subtracted yet.
- EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization. Compared to operating income, it even strips out non-cash charges like depreciation and amortization in order to account for a firm’s operational performance in a supposedly more accurate way.
- Gross & Operating Margins. A good way to assess a company’s efficiency is using profitability ratios like the gross and operating margin which both gauge the percentage of generated income in two different stages within an income statement. The gross margin represents the amount of retained revenue after incurring directly associated costs while the operating margin measures the operating income as a percentage of revenue.
Analyzing the Firm’s Cashflows
Many investors and companies oftentimes seem to overlook the importance of cash flows while focusing too much on the earnings-per-share metric and whether it has beaten expectations or not. At the end of the day, what the shareholders of a company should care about the most are the cash flows that the business generated which then can be returned in form of dividends or share buybacks.
In practice, cash flows are almost never the same as earnings because of how accountants record the income and expenses within a business in order to provide and standardize financial information consistently across all companies.
Common examples that make earnings different from cash flows are depreciation and amortization. Both line items are non-cash expenses, meaning that they don’t actually involve any cash transaction and therefore do not affect cash flow.
Such non-cash charges and other adjustments can often heavily affect the earnings figure of a business, leading to scenarios, where a company could report negative earnings while still being cash flow positive.
»Learn more about the difference between net income and free cash flow
Therefore, a good way to analyze a company’s performance when earnings-per-share is negative is to check its cash flows instead. A commonly used counterpart to EPS would be free cash-flow per share (FCF) which simply takes the firm’s free cash flow into account instead of its net income.
Here is a chart of Tesla Inc’s EPS and FCF over the past years:
What’s interesting to note here is that the company already became cash-flow positive in 2019, one year before it reported positive earnings in 2020. If we tried to analyze Tesla’s EPS before the fiscal year of 2020, we wouldn’t be able to interpret a lot out of the firm’s performance, whereas its free cash flow figures would indicate that the company is actually generating excess cash.
Conclusion
- Negative earnings per share can only be the result of a firm’s unprofitability in the given accounting period.
- There can be different reasons for negative earnings which is why it’s important to figure out what exactly led to the company being unprofitable.
- There are several other approaches to analyzing a company’s performance if it reported negative EPS in the first place.
