What is the Earnings Estimate?

How to Calculate Earnings Per Share Estimation?

The market usually does not want to see a company’s total earnings for the share price estimation. Therefore, the most useful data is EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company’s performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more estimation.

Earnings Per Share = Total Earnings / Total Shares Outstanding

Let us take the example of ABC Co. It has 5 product lines. The revenue from each product line from the last quarter is given below: –

  • Product LineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more A: $5 million (seasonal product, the season starts from January to June)Product line B: $3 million (seasonal product, starts from July to December)Product line C: $4 million (luxury product)Product line D: $8 million (Fast Moving Consumer Goods – FMCGs)Product line E: $2 million (car production)

What factors may an analyst consider and estimate the EPS for the next quarter from July to September? In addition, the total shares outstanding in the market is 10 million.

Solution:

There are several factors that an analyst should consider to calculate earnings per share for the next quarter. First, the analyst must study each product line very carefully.

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Product Line A

It is a seasonal product. We see that its season just ended. So, the last quarter, April – June, earned the company $5 million in revenue. So, it is expected that the revenue may not be the same from this product line this quarter as it is seasonal and just ended. So, the analyst may have to see the past 5 to 10 years’ record and analyze what was the drop in the sales for this product line after June. Say, the drop was 45% on average. So, he may have to take a call as to whether he should consider 45% or lower or higher for this year. Say for this year; he thinks the drop will even be more. So, the analyst considered a drop of 55%, i.e., -55%.

$5 million * 55% = $2.75 million.

Expected revenue from product line A for the next quarter (July to September)

  • = $5 million – $2.75 million= $2.25 million.

Product Line B

It is also a seasonal product whose season is just about to start. So, the analyst will again view the past year’s data and see the rise in sales from July. For example, the average rise in sales from July for the past ten years is 40%. So now, the analyst may take a call as to what he should consider for this year. Say the football World Cup is scheduled to happen this quarter. This product is related to sports. So, the increase in revenue estimation should be more than 40%. Suppose the analyst considered the rise in revenue to be 50%. i.e., +50%.

$3 million * 50% = $1.5 million

Expected revenue from product Line B for the next quarter (July to September)

  • = $3 million + $1.5 million= $4.5 million.

Product Line C

Luxury product sales depend on the purchasing capacity of the country. Therefore, to estimate the sale of a luxury product for the next quarter, the analyst will have to calculate the GDP growth rate, the quarter’s per capita incomePer Capita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc.read more, and any financial distressFinancial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more for the quarter. After considering all the factors, analysts decide that the sale will drop by 10% for the next quarter, i.e. (- 10%).

$4 million * 10% = $4 lakh

Expected revenue from product line C for the next quarter (July to September)

  • = $4 million – $4 lakh= $3.6 million.

Product Line D

Fast Moving Consumer Goods (FMCGFMCGFast-moving consumer goods (FMCG) are non-durable consumer goods that sell like hotcakes as they usually come with a low price and high usability. Their examples include toothpaste, ready-to-make food, soap, cookie, notebook, chocolate, etc.read more) are sold mostly throughout the year. So, for this, the analyst can calculate the revenue by seeing the past ten years of data and seeing if any outliers are present. For example, say there was a drop in sales in a particular year due to a flood; then, the analyst will have to remove this outlier before doing the calculation if the analyst finds out that the sale of this product remains constant for the next quarter as compared to the previous quarter.

Expected revenue from product line D for the next quarter (July to September)

  • = $8 million.

Product Line E

Car sales depend on many factors. The price of fuel, economic conditions, pollution control laws, availability of steel, and many others. So, the analyst should predict the movement of all the factors and then estimate the sales percentage of the car for the next quarter. For example, suppose an analyst finds out that car sales will increase by 20% for the next quarter (i.e., + 20%).

$2 million * 10% = $4 lakh

Expected revenue from product line E for the next quarter (July to September)

  • = $2 million +$4 lakh= $2.4 million.

So, the total estimated revenue of ABC Co. for the next quarter can be calculated as follows: –

Revenue from product A + Revenue from product B + Revenue from product C + Revenue from product D + Revenue from product E

  • = $2.25 million + $4.5 million + $3.6 million + $8 million + $2.4 million= $20.75 million.

  • = $20,750,000 / $10 million= $2.075

So, $2.075 is the earnings per share estimate for the next quarter.

Refer to the Excel sheet given above for detailed calculations.

Earnings Surprise and How does it Affect Share Price?

Earning surprise is when the company earnings are below or above the estimated.

A positive surprise is always good for the company. A positive surprise means when the actual earnings are more than the estimated earnings.

We see a share price in the market based on several factors; earnings are one among them. The present value of all the company’s future earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more earnings reflects in the share price. So, when there is a positive earnings surprise, the earnings are more than estimated. It is calculated by the share price you see in the market with the help of estimated earnings. As the actual earnings have beaten the estimate, one must include new information in the calculation, so the share price rises.

Conclusion

Earnings estimate is a very important factor in the market. It helps in determining the share price. It is always good for a company to beat the earnings estimate as it helps build a reputation for the company in the long run.

This article is a guide to Earnings Estimate. Here, we discuss how to calculate earnings per share, examples, and how it affects the share price. You can learn more about it from the following articles: –

  • Stock HaltPresent ValueWhat is Earnings Call?Earnings Management