Trailing EPS: A Simple Guide

As an investor, your only objective is to make a profit. Over the last few years, the market has changed significantly. Previously, people followed a conservative approach by investing in instruments like fixed deposits. However, with the decreased rates of traditional investment avenues, more and more people are turning to the stock market.

Investing in stocks enables you to benefit from market movements and grants you partial ownership in the company whose shares you have invested in. However, when selecting an ideal investment, you need to consider many metrics that help you gauge a company’s financial health. One such metric is Trailing EPS; we will discuss it in detail in this article.

What is Trailing EPS?

Trailing Earnings Per Share (EPS) is a financial metric that represents a company’s profitability over a specific past period. This period can be the last fiscal year or the most recent four quarters. 

Trailing EPS is computed by dividing the net earnings of the company by the number of outstanding shares of its common stock during that period. The term “trailing” indicates that the calculation is based on historical data to provide a snapshot of the company’s earnings performance on a per-share basis.

Importance of Trailing EPS

• It is a crucial metric for calculating the Price-to-Earnings (P/E) ratio, which helps investors determine if a stock is over or undervalued.

• Companies often use trailing EPS to benchmark their performance against competitors and industry standards.

• Since dividends are typically paid out of profits, a stable or increasing trailing EPS can indicate a company’s ability to maintain or raise its dividend payouts.

• Analysts use trailing EPS to perform trend analysis, comparing quarter-over-quarter and year-over-year earnings to assess the company’s growth trajectory.

• A declining trailing EPS may signal potential risks and challenges the company faces, prompting investors to exercise caution.

• For specific sectors, like retail, trailing EPS can be particularly important for evaluating seasonal performance, such as the impact of holiday sales.

• A higher trailing EPS can indicate better liquidity. It suggests that the company has more funds available for investment and operations.

How does Trailing EPS work?

Here’s a trailing EPS example to help you get the concept better:

Let’s consider a hypothetical company, ABC Ltd. The company has reported its quarterly earnings for the past four quarters as follows:

• Q1: Rs 50 lakhs
• Q2: Rs 55 lakhs
• Q3: Rs 60 lakhs
• Q4: Rs 65 lakhs

The total net income for the past 12 months (trailing twelve months) would be the sum of these four quarters:

= (Rs 50 lakhs + Rs 55 lakhs + Rs 60 lakhs + Rs 65 lakhs)

= Rs 2.30 Crores

Next, you must account for any preferred dividends paid out during this period. These dividends are payments made to preferred shareholders that must be deducted from the net earnings to determine the income available to common shareholders. 

Suppose ABC Ltd paid Rs 10 lakhs in preferred dividends during the last 12 months:

Earnings available for common shareholders = (Rs 2.30 – Rs 10 lakhs)

= Rs 2.20 crores

Now, assume that at the beginning of Q1, there were 9 lakh shares outstanding. During Q3, the company issued an additional 1 lakh shares, bringing the total to 10 lakh shares for the remainder of the year. 

Average Outstanding Shares = (Shares at the Beginning of Q1 + Shares at the End of Q4) ÷ 2

= (9 lakhs + 10 lakhs) ÷ 2

= 9.5

Finally, you have all the figures to compute the trailing EPS.

Trailing EPS = (Earnings Available for Common Outstanding Shares ÷ Average Outstanding Shares)

= (Rs 2.20 Crores ÷ 9.5 lakhs)

= Rs 23.16

Limitations of Trailing EPS 

• This concept may not accurately represent a company’s value in cyclical industries with significant earnings fluctuations. For instance, during economic downturns, depressed earnings can lead to an inflated trailing EPS, misrepresenting the company’s true value.

• The metric can be skewed by extraordinary items such as restructuring charges or asset sales, which may not recur in the future. These one-time events can artificially inflate or deflate the trailing EPS.

• Trailing EPS is not useful for companies that are not profitable. It does not apply to firms with negative earnings. Other metrics are needed to assess the company’s value in such cases.

• The calculation of trailing EPS may vary between companies. This lack of standardisation can make using trailing EPS as a comparative tool challenging.

• Companies that engage in share buybacks can artificially boost their trailing EPS by reducing the number of outstanding shares, which may not necessarily reflect an improvement in actual profitability.

• Trailing EPS does not take into account a company’s capital structure. A highly leveraged company may have a high EPS due to fewer shares but could be at greater financial risk.

Alternatives to Trailing EPS 

• Forward P/E: This metric uses future earnings guidance rather than past figures.

• Price/Sales (P/S) Ratio: The P/S ratio compares a company’s stock price to its revenue to offer insight into value without factoring in earnings.

• Price/Book (P/B) Ratio: This ratio contrasts the market’s valuation of a company to its book value. It demonstrates the willingness of investors to pay for each dollar of a company’s assets.

• Enterprise Value Multiples: These include EV/EBITDA or EV/Sales, which consider a company’s value from an acquisition perspective, including debt and excluding cash.

• Dividend Yield: For income-focused investors, dividend yield can be a more relevant metric than EPS, as it indicates how much a company pays out in dividends relative to its share price.

• Cash Flow Metrics: Free cash flow per share or operating cash flow per share can provide a clearer picture of an organisation’s financial health. They are less susceptible to accounting adjustments than earnings.

Understanding Trailing EPS Vs. Rolling EPS

Since by now you have a clear understanding of the trailing EPS, let’s directly discuss the rolling EPS. 

Rolling EPS combines actual past earnings with estimated future earnings for the next two quarters. It is computed by adding the net income from the past two quarters to the estimated net income for the next two quarters and then dividing it by the average outstanding shares.

Conclusion

Trailing EPS provides insights into a company’s profitability, influences stock valuation through the P/E ratio, and aids in comparing against industry standards. However, this metric has limitations. Trailing EPS might not work in cyclical industries and during extraordinary events. 

It is recommended that this metric be used in conjunction with forward P/E, dividend yield ratio, P/B ratio, and a few others. 

Frequently Asked Questions