The 3 Ways A Company Can Grow Its Earnings Per Share

One of the ways a company can deliver returns for its investors is to grow its earnings per share. But, how exactly can a company do so?

In this article, we will look at the different ways a company can grow its earnings per share.

Revenue growth

The most obvious way for a company to grow its earnings is to grow its revenue. There are in turn, three ways a company can generate higher revenue – it can increase its sales volume, ramp up the prices it charges, or implement a combination of both.

To increase volume, a company can employ strategies such as new market or product development or diversify into new business segments. Price increases can be more challenging to implement and is generally better suited to companies with pricing power.

In Singapore’s stock market, an example of a company that has grown its earnings per share with the help of higher revenue is healthcare services outfit Raffles Medical Group Ltd (SGX: BSL). From 2011 to 2015, the company’s revenue increased by 50% from S$272.8 million to S$410.5 million while its earnings per share stepped up by 28%.

Margin expansion

Profit is calculated by subtracting costs from revenue. Therefore, one way for a company to increase its profit is through lowering its costs as a percentage of revenue – this is also known as margin expansion.

One company in Malaysia’s stock market that has successfully grown its earnings per share with this method is Nestle (Malaysia) Berhad (KLSE: NESTLE).

From 2006 to 2015, Nestle Malaysia’s revenue is up by ‘just’ 48% whereas its earnings per share is up by 124%. The higher earnings per share growth is due mainly to an expansion of the company’s net income margin from 8.1% to 12.2%.

Financial engineering

The two earlier methods for a company to grow its earnings per share can generally be classified under the category of improved business performance. The last method is to depend on financial engineering.

One of the most common and well-known financial engineering methods to increase earnings per share is to use share buybacks. Earnings per share is calculated by dividing a company’s net income with its outstanding share count. Share buybacks reduce the denominator and thus improve earnings per share even if net income stays constant or decreases.

A simple illustration can help make this clearer. Let’s assume we have a business that makes a profit of $1 million with 1 million shares issued. Its earnings per share is thus $1. If this company buys back 500,000 shares using the excess cash it has, the same $1 million in profit will result in an earnings per share of $2 instead (S$1 million divided by 500,000).

A company that has used this method to increase its earnings per share is AutoNation, Inc, an American car retailer.

From 2006 to 2015, AutoNation’s net income had climbed by less than 50% from US$317 million to US$443 million. Yet, the company’s earnings per share had jumped by 179% from US$1.407 to US$3.927 due to a sharp reduction in its share count from 225.2 million shares to 112.7 million.

A Foolish conclusion

By understanding the different ways a company can grow its earnings per share and its preferred methods, investors can make better assumptions about a company’s future growth.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Raffles Medical Group and Nestle (Malaysia). Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.