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I'm Expecting An Old Friend May Drop by for Q4 - Higher EPS Due To Share Count Reduction

Posted by: Howard Silverblatt on December 20, 2010

I have noted an increasing number of companies which have completed share buybacks in excess of their internal use for employee options and M&A over the first three quarters of this year. The practice, know as Share Count Reduction (SCR), reduces the actual number of shares outstanding, which are used to determine earnings per share (EPS). The result permits companies to report a higher rate of increase for EPS than their aggregate net income. For example, if a company makes US$ 1 billion and has one billion shares outstanding, their earnings per share are US$ 1. However, if they reduce their share count by 5% to 950 million, the same net income will result in an EPS value of US$ 1.05. The practice of share count reduction was very popular in the 2005-7 time period, but has fallen out of fashion due to both the recession and liquidity concerns. For the third quarter share count reductions of at least 2% have picked up considerably, relative to where they have been, with the cumulative change in shares outstanding since the end of 2009 for at least 45 issues in the S&P 500 are now sufficient enough to impact their fourth quarter earnings per share. Given the lack of SCR impact over the past several years, I have some concern that street earnings estimates may not reflect the lower share count, with the result being that initial EPS reports will appear to have beaten their estimates, and the quick market reaction being an upswing in the stock price. Once fully disseminated and interpreted, any incorrect market action will be corrected. Trades, however, will have been made, with profits and losses posted. Given that analysts had adjusted estimates for SCR several years ago, I believes that they will quickly react to the situation, but most likely not until there have been several published examples (and trades) of the situation. It’s not 2005-7, but companies appear to be a bit more aggressive with their authorizations - which do not necessarily translate into actions.

See attached for a detailed report on buybacks Buybacks_20101220.doc

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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