2.1 The following figures have been calculated from the financial statements (including comparatives) of Zola (Pty) Ltd for the year ended 30 September 2009:
increase in profit after taxation 80%
increase in (basic) earnings per share 5%
increase in diluted earnings per share 2%
REQUIRED:
Explain why the three measures of earnings (profit) growth for the same company over the same period can give apparently differing impressions. (6 Marks)
The three measures of earnings growth - increase in profit after taxation, increase in (basic) earnings per share, and increase in diluted earnings per share - can give apparently differing impressions due to the following factors:
1. Different calculation methods: Each measure calculates earnings growth using a different formula. Profit after taxation measures the overall increase in net income, while basic earnings per share divides the net income by the average number of shares outstanding to show the earnings per share. Diluted earnings per share takes into account the potential dilution of shares from stock options, convertible securities, or other potential additional shares, resulting in a lower earnings per share figure. Therefore, the different formulas used can lead to different growth rates.
2. Changes in the number of shares: If the number of shares outstanding has changed during the period, it can affect the calculations of earnings per share measures. For example, if a company has bought back shares, the decrease in the number of shares will result in a higher earnings per share figure, even if the overall profit after taxation has not increased significantly. Conversely, if a company has issued new shares, it may dilute the earnings per share even if the profit has increased.
3. Changes in the profit mix: The increase in profit after taxation may not necessarily reflect the growth in earnings per share if there have been changes in the profit mix. For example, if a company has experienced a significant increase in revenue but also higher expenses, the profit after taxation may show a large increase, but the earnings per share may not increase proportionately due to the increased expenses impacting the net income. Similarly, if a company has increased its profitability in a certain segment of its business, it may lead to a higher profit after taxation, but if that segment's contribution to the overall earnings per share is low, then the increase in basic and diluted earnings per share may be lower.
4. Impact of exceptional items: If there are exceptional items, such as one-off gains or losses, included in the profit after taxation figure, it can distort the overall growth rate. These items can significantly impact the profit figure, but may not have the same effect on the earnings per share calculations. Therefore, the presence of exceptional items can lead to different growth rates for the three measures.
In summary, the apparent differences in the three measures of earnings growth for the same company over the same period can be attributed to the different calculation methods, changes in the number of shares, changes in the profit mix, and the impact of exceptional items. It is important to consider these factors and analyze each measure in conjunction with other financial data to gain a comprehensive understanding of a company's earnings growth.