Scribd
Upload
52 views6 pages

Reverse Engineering EPS To Get Expected Revenue

The document discusses reverse engineering analyst EPS estimates to gauge expectations and check for optimism. It provides an example using VistaPrint, showing that an analyst EPS estimate of $2.73 implies unrealistic revenue growth compared to historical trends. The author advocates normalizing earnings over past periods instead of relying on single estimates. Reverse engineering EPS is presented as a simple way to evaluate sentiment reflected in stock prices and analyst estimates.

Uploaded by

carminat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
52 views6 pages

Reverse Engineering EPS To Get Expected Revenue

The document discusses reverse engineering analyst EPS estimates to gauge expectations and check for optimism. It provides an example using VistaPrint, showing that an analyst EPS estimate of $2.73 implies unrealistic revenue growth compared to historical trends. The author advocates normalizing earnings over past periods instead of relying on single estimates. Reverse engineering EPS is presented as a simple way to evaluate sentiment reflected in stock prices and analyst estimates.

Uploaded by

carminat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 6

oldschoolvalue.com http://www.oldschoolvalue.com/blog/?

p=14560&preview=true

Reverse Engineering EPS to get Expected Revenue


X-Men.

Spiderman.

My occasional cooking.

These things show that some of the coolest things happen from side effects.

As I’ve been digging deeper into the EBIT multiple calculator recently implemented into the Stock Analysis Tool , I
made an accidental discovery.

In all the stock valuation methods that I use, I’ve gone over how you can do it in reverse to gauge the expectations
for a stock.

With a DCF, you do a reverse DCF to see what growth rate estimates are being assumed by the market at the
current price.

The reverse Graham method gives you a ballpark growth estimate based on the EPS.

With EPV, since it ignores growth to begin with, you can see what value the market is placing on its reproduction
value and earnings power.

Using the EBIT multiple method, it’s easy to start with the analyst EPS and then work your way up to figure out what
the expected revenue is for the upcoming year based on that EPS.

Reverse Engineer the EPS to Check How Optimistic It Is

Now I’m liking this idea more each day because it provides a very simple frame of reference.

Let me explain.

Let’s say you did a reverse DCF and the current price is assuming a growth rate of 13%.

Great.

But what is that 13%?

Since 13% is not an absolute number, it’s difficult to fully capture the meaning behind it.

Compare it to revenue.

If a company has managed to grow sales to $1M at 15% a year, but reverse engineering an analysts EPS shows that
the expected revenue for the next year is $2M (a 100% jump), how likely are you to believe that EPS estimate?

See how simple it is to check how realistic an analyst estimate is?

Analyst estimates are overly optimistic so it’s always a good idea to check.
Optimistic Analyst Estimates

Why Analysts are Overly Optimistic with VistaPrint (VPRT)

BeyondProxy.com posted a commentary on VistaPrint which I liked and wanted to look more into.

After all, I’m very familiar with the company and printing industry. Maybe the recent 20% drop was an opportunity so I
wanted to see whether it was cheap enough to consider.

Over the past few years, margins have been getting hammered.

When you do a forward looking valuation, it’s best to take a 5 year or 10 year normalized period to see what the
intrinsic value will be if the company gets back to “normal”. Then do the same for a shorter period for the bleak
valuation. This will give you a range and an idea of what to expect.

(I’ll show you how to normalize values in the following sections)

However, when you do any sort of reverse stock valuation, you should always use a much shorter period. You want
to see what the expectations are with the stock now.

So starting with the analyst EPS of $2.73, if I use a short 3 year normalized period, the expected revenue turns out to
be $1,734M in the coming year.
Vistaprint Reverse Revenue Calculation Shows Optimistic Assumptions | Enlarge

Compare that to the TTM revenue of $1,213M.

Vistaprint Revenues | Enlarge

$1,734M is way too optimistic compared to the growth over the past 3 years.

A better way is to use a simple normalized EPS.

In this case, the normalized EPS I’m using is $1.99.

For OSV users, just flip the selection to Normalized EPS to see what you get.

Vistaprint Reverse Revenue using Normalized EPS | Enlarge

The expected revenue using an EPS of $1.99 is much closer to what you would expect.

Easy right?

Well, if you aren’t a member of old school value, I’ll give you step by step instructions on how to do this manually.

But you must understand how to normalize numbers first.

How to Normalize Earnings


To normalize earnings, I’m just following what Prof Damodaran teaches. Here’s the original page on normalizing
earnings which includes extra commentary on when to use it and how to think about it.

I’ve taken the part that tells you how it should be done.

Average the firm’s return on investment or profit margins over prior periods:

This approach is similar to the first one, but the averaging is done on scaled earnings instead of dollar earnings.

The advantage of the approach is that it allows the normalized earnings estimate to reflect the current size of the firm.
Thus, a firm with an average return on capital of 12% over prior periods and a current capital invested of $1,000
million would have normalized operating income of $120 million.

Using average return on equity and book value of equity yields normalized net income.

A close variant of this approach is to estimate the average operating or net margin in prior periods and apply this
margin to current revenues to arrive at normalized operating or net income.

The advantage of working with revenues is that they are less susceptible to manipulation by accountants.

Step by Step Guide to Normalizing Earnings

So in the example above there are two ways to normalize earnings.

1. Using the average ROE to find net income


2. Get the average net margin and multiply to current revenues

Let’s take a look at both.

Using Average ROE to Get Normalized Earnings

Step 1. Get 3 to 5 years of ROE

Step 2. Average the ROE

Step 3. Multiply the average ROE from Step2 with the shareholders equity found in the latest quarterly statement

Step 4. Divide the value from step 3 by shares outstanding to get normalized earnings.
Normalize Earnings using Average ROE

Using Average Net Margin to Get Normalized Earnings

Step 1. Get 3 to 5 years of net margin

Step 2. Average the net margins

Step 3. Multiply the average net margins from Step2 with the latest revenue numbers to get the normalized net
income. I like to use the TTM revenue value.

Step 4. Divide the value from step 3 by shares outstanding to get normalized earnings

As you can see there are differences


between the two methods. Choose
the method that you like.

I’m using the net margins method


because it gives a better indication of
the business cycles and I’ve adjusted
my version to use median numbers
instead of averages.

That’s why the value of $1.99 used in


the example is slightly higher that
what you see here.

But Isn’t Revenue Unreliable Normalize Earnings using Net Margins


because It’s Easy to
Manipulate?
Revenue is easy to game, but not manipulate.

Prof Damodaran says it himself.

The advantage of working with revenues is that they are less susceptible to manipulation by
accountants.

And the reason is because while you can game when the revenue is recognized but you can’t fake what the price of a
product or service is and how much a customer paid.

Sure, many companies want to meet sales goals so they offer certain discounts and incentives to customers if a
purchase is made within the quarter.

But at the end of the day, the revenue line is still important.

After all, it’s what the product/service costs. You can’t play around with basic prices.

In the private sector where there is no luxury of EPS and shares outstanding to calculate all sorts of stock valuation
ratios, revenue plays a big role. Even in the private online world, websites are sold based on a multiple of revenue or
normalized net income.

What Do You Think About Reverse Engineering the Analyst EPS to Gauge Sentiment?

Using this method, it’s easier than ever to get an idea of the sentiment towards a stocks.

Previously I was doing reverse valuations to get the expectations. This is another method that makes it even easier.

What do you think?

Disclosure: None

About Jae Jun

Jae Jun is the founder of Old School Value. He is on a mission to provide practical and actionable value
investing tools, tutorials and educational material to help empower the individual investor. Keep in touch
with Jae via any of the methods linked below.

You might also like