EPS as a Measure of Intercompany Performance: Philippine Evidence

INTRODUCTION International Accounting Standards (IAS) 1 states that the objective of financial reporting is to provide information that is useful to a wide range of users. Stice, Stice and Skousen (2007) explain that an investor uses this financial information in making credit and investment decisions. Investors gauge how well a company performs in comparison with other companies. Profitability is one of the basic indicators of the soundness of a business entity. However, it is not enough to know whether net income is increasing or decreasing. Investors are concerned with how income is changing relative to certain factors such as firm size. The analysis of the financial performance of a business becomes more meaningful when profit is scaled against acceptable measures of firm size such as total assets and sales. Ratios such as return on assets (ROA) and return on sales (ROS) are commonly used to evaluate the results of business operations. Another popular measure of income performance is Earnings per Share (EPS). It is a ratio which incorporates both net income and outstanding ordinary shares in the measurement of profit performance. In this tool, the number of ordinary shares is proposed as a measure of firm size. This financial ratio is very important to most users, particularly the ordinary shareholders because EPS information is helpful to them in evaluating the return of their investment and risk of a corporation (Nikolai and Bazley, 2003). Questions now arise. Can EPS be used in making comparisons across companies? Can outstanding ordinary shares be used as a measure of firm size? To help illustrate this concern is the case of two local companies in the Philippines, namely, Pilipinas Shell Petroleum Corporation and TI Inc. These are two large corporations with similar asset size. Both companies have total assets of approximately P59 billion as of December 31, 2007. For the year ending 2007, Pilipinas Shell and TI Inc. posted net income of P 6.4 million and P5 million respectively. Given this information, the net income of Pilipinas Shell exceeded the net income of TI Inc. by P1 million. Scaling these profit figures by total assets resulted in Pilipinas Shell and TI Inc. providing returns on asset investment of 10.61% and 8.55%, respectively. These percentages reinforce the early observation that Pilipinas Shell is more profitable than TI Inc. But in terms of EPS, Pilipinas Shell registered EPS of P9.19 while TC Inc. posted an EPS of P524.64. This contradicts the previous analysis that Pilipinas Shell performed better than TI Inc. It can be seen therefore that when EPS is used as a measure of financial performance, the landscape of the profitability picture changes. This change can be attributed to the number of outstanding ordinary shares which is the measure of firm size used in the EPS ratio. In this particular case, Pilipinas Shell has 68 times more outstanding ordinary shares than TI Inc. The analysis of the income performance of these two corporations reveals the possible drawbacks of comparing profitability among firms using EPS. The landscape of a firm's profit picture changes when the number of ordinary shares is taken into consideration. It is in this light that this research paper is undertaken. This study determined if the number of ordinary shares is an acceptable measure of firm size that can be used in evaluating the reasonableness of using EPS as a tool of measuring financial performance across corporations in the Philippines. BACKGROUND LITERATURE International Accounting Standards (IAS) 33 defines EPS as the amount of net income attributable to every outstanding ordinary share during a period of time. The standard states that the purpose of presenting EPS is to provide financial statement users with information on the performance of a single entity. Creditors and investors find this measurement tool as an effective way of evaluating the income performance of each outstanding ordinary share. …