Module 31.4, LOS 31.e: Normalizing EPS

The P/E ratio depends on estimating an appropriate earnings value. An analyst may take several adjustments for their earnings value, such as stripping away non-core components like provisions for future losses and asset write downs. This allows analysts to focus on the underlying earnings, which are core sustainable earnings. It is also good practice to use the diluted EPS to consider things like share options that may impact the EPS.

For very cyclical businesses, analysts can normalize earnings per share to smooth the P/E over time. The two ways to normalize EPS are through historical average or by using the average return on equity times the book value per share of a firm:

               Normalized earnings (ROE) = average ROE x BVPSEOY

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