What is proforma EPS?

Proforma EPS is an indicator that measures how much earnings per share two companies could have in total if one acquired another or they merged together.

Is proforma EPS indicator important?

For the analysts of a company that is planning to make acquisitions, this indicator might show if the deal will have positive or negative consequences.

To calculate it, add up the target’s and acquirer’s earnings and incremental adjustments, then divide the sum by the acquirer’s number of outstanding and new shares issued.

Incremental adjustments in this equation mean potential gains and losses that the deal might result in. An example is Amazon acquiring a robotics company called Kiva back in 2012.

Those robots helped Amazon save between 400 and 900 million dollars in annual running costs. But of course, not every deal might bring a company such benefits.

What is a good proforma EPS?

A good proforma EPS is the one that is higher than the EPS of the acquirer before the deal, resulting in an accretive acquisition or merger.

Can proforma EPS be negative?

Theoretically, pro forma EPS can be negative if one side of the deal has suffered greater losses than the other side’s income or if incremental adjustments are negative.

But practically, it’s unlikely that a company will attempt to make a dilutive acquisition or merger, which will result in proforma EPS dropping below pre-deal EPS.

What are the limitations of proforma EPS?

The main limitation of proforma EPS is that it cannot be used alone and should be combined with other indicators to make the analysis clearer.

This is because, according to corporatefinanceinstitute.com, “there are situations where EPS can increase but the value of the merged firm is lower than the sum of the acquirer and target.”

Additionally, the use of proforma EPS is limited, and it does not provide any insights on the underlying economics of a business, so it will be hard to implement in stock research.

How do I use proforma EPS?

Due to these issues, retail investors will rarely use proforma EPS, mostly in cases where the stock they hold announces an acquisition or merger with another business.

For instance, in January 2022, Microsoft Corporation announced the acquisition of Activision Blizzard, Inc., for $95 per share. At that time, using proforma EPS, we could check if the deal was good.