Earnings per share" (EPS) is the most commonly featured financial statistic for corporations. For many securities, the daily published quotations of share prices include a "times earnings" figure that is based on EPS. Stock analysts often focus their discussions on the EPS of the corporations that they study.
(a) Explain how the calculation of EPS is affected by dividends or dividend requirements on classes of preferred shares that may be outstanding.
(b) One of the technical procedures that applies to EPS calculations is the treasury stock method. Briefly describe the circumstances that can make it appropriate to use the treasury stock method.
(c) Convertible debentures are considered potentially dilutive common shares. Explain how convertible debentures are handled in regard to EPS calculations. Does the treatment change if the convertible bond can be settled in cash or shares at the issuer's option?
(d) Recently, an article in Report on Business magazine titled "The magic number: The price-to-earnings ratio deserves its favoured status-as long as you use it right," written by Fabrice Taylor (February 2010), noted that the long-term average of all shares for the "times earnings" figure was about 19 times. Taylor went on to state that Maple Leaf Foods Inc. was (currently) trading at a P/E (price-to-earnings) ratio of 100 times EPS for 2008, and Finning International Inc. was trading at a P/E ratio of 442 times the past year's EPS. Maple Leaf Foods in the past year had suffered large losses due to product recalls. Finning is a seller of Caterpillar equipment whose sales and earnings fluctuate with commodity prices.
Are these companies' share prices too high? What might be causing these times earnings multiples to be so high? What other information would be needed before this determination could be made? (AICPA adapted)