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While earnings per share can be an important factor to consider in an investment, it's not a flawless measurement. Sometimes one-time adjustments can get in the way of an otherwise positive earnings report, leading to unreasonably low stock prices. When these situations happen, it's important for investors to research whether one-time charges are the reason for underwhelming EPS and whether shares have become a good value. Let's look at a few examples.
Investment banking gone wild
JPMorgan Chase (NYSE: JPM ) can hardly be mentioned today without bringing up the subject of the London Whale. In a massively bad bet, the investment bank lost more than $6 billion and now faces fines of nearly $1 billion on top of that.
But the London Whale fine is small compared with what's reported as being negotiated behind closed doors. Some reports indicate that a mortgage securities settlement between JPMorgan and the government could run as high as $11 billion.
This news has caused fear to encircle shares of JPMorgan, with the stock now trading for a price-to-earnings ratio in the single digits despite strong growth prospects ahead. The lawsuits are examples of one-time costs that would have near-term effects but are unlikely to materially affect JPMorgan in the long term.
Despite the enormousness of $11 billion to the average investor, it's not a settlement that would threaten to bankrupt JPMorgan. Last year, JPMorgan's profit was nearly double that amount, and future years call for continuing increases in earnings.
Those who see JPMorgan as extremely undervalued may want to have a look at JPMorgan warrants (NYSE: JPM- ) . These warrants are long-dated originating from the TARP bailout program in 2008. They carry a strike price of $42.42 per share and expire Oct. 28, 2018.
After the lawsuits have blown over, JPMorgan may even decide to raise its dividend to better attract income investors. For those holding JPMorgan shares, it would mean additional dividend income. And for holders of the warrants, any dividend increase beyond the current dividend begins to adjust downward the strike price of the warrants.
The friendly skies
United Continental Holdings (NYSE: UAL ) has seen its fair share of troubles over the past few years. It turns out that merging United Airlines and Continental Airlines is no easy task, especially when technical glitches cause havoc and annoy passengers.
But United Continental's 2012 earnings really look ugly now, thanks to a one-time merger charge relating to labor. As a result, United Continental has a 2012 EPS of -$2.18.
However, United Continental is making progress in its merger. The reservation systems are integrated, the planes are painted, and seniority lists between United Airlines and Continental Airlines are merged, clearing the way for United Continental to make more efficient use of its pilots.
Challenges still do remain at United Continental, but there is finally a light at the end of the tunnel. Not only were the past year's earnings greatly affected by a massive one-time charge, but United Continental can also now begin to realize merger synergies for future years.
Investors looking for better returns in the long run must look at companies for more than short-term effects. At JPMorgan Chase and United Continental, one-time charges are causing Wall Street to look at these stocks in an unfavorable light.
Investors should use their own investment strategy to consider whether to add companies with short-term issues but long-term positives to their portfolio.
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