Monday Q&A

A question came in regarding our use of a weighted average.  lppm05 wants to know how we calculate the weighted average when determining our figure for EPSmg.  What we do is use a sum-of-the-years-digits method for the average.  For example, using Microsoft (MSFT), here are the last five years of diluted EPS (note their fiscal year ended 6/30/08):

2008  — $1.87
2007  — $1.42
2006  — $1.20
2005  — $1.12
2004  — $0.75

To use the sum-of-the-years-digits method, we simply multiply the EPS for the given year by the number of the year divided by the total sum of the years.  Continuing with our example, the weighted amount for 2008 was $1.87 x (5/15) = $0.62333.  For 2007, we would get $1.42 x (4/15) = $0.37867.  Once you have completed calculating the weighted amounts for all the years, simply add up the totals to find the EPSmg for 2008.  We found the EPSmg to be $1.44 in this case.

You can see that the EPSmg is lower than the current figure.  This may or may not be true in all cases.  If a company has a significantly low result in the current year, the EPSmg will be higher.  The whole purpose is to smooth out the business cycle to determine a normalized earnings.  We believe that completing this task is the first step in evaluating a company.

If you have any questions for us, please let us know by leaving a comment below or emailing me at ben@moderngraham.com.