Basic and diluted earnings per share (EPS)
Earnings per share (EPS) is a closely-watched business metric that tells analysts and investors how much a corporation is making on a per-share basis. In this article, we’ll describe basic EPS in detail, and then briefly describe the diluted EPS calculation.
1. Basic earnings per share
In its simplest form, basic EPS can be found by dividing net income by the number of shares outstanding. However, if the company has any preferred stock, we first need to subtract preferred dividends from net income. We do this because EPS is calculated based on the income available to common shareholders.
A second potential wrinkle in the calculation occurs when the number of shares outstanding changes during the period. If that has happened, we use the time weighted number of shares outstanding. Let’s look at an example.
XYZ Corporation has 200,000 common shares outstanding at the beginning of 20X4. Net income for the period was $1.5 million, and the corporation paid a $100,000 preferred dividend on September 1. An additional 20,000 common shares were issued on July 1.
The numerator of our calculation will be $1.5 million - $100,000, or $1.4 million. For the denominator, we need to determine the weighted number of shares outstanding because the number changed during the year. To weight the number of shares, multiply the number by how many months they were outstanding, then divide by 12:
[200,000 outstanding at beginning of 20X4] x 12 ÷ 12 = 200,000
[20,000 outstanding on July 1, 20X4] x 6 ÷ 12 = 10,000
The denominator will be 210,000 (i.e., 200,000 + 10,000) shares outstanding, which means that basic EPS will be:
EPS = $1.4 million ÷ 210,000 = $6.67
Note that any shares repurchased by the corporation as treasury stock should not be included in the denominator. In addition, stock dividends increase the number of shares in each share block outstanding before the dividend. For example, if a 10% stock dividend was declared on March 1 in the previous example, the 200,000 weighted share block would be increased to 220,000, but the 10,000 block would stay the same. This dividend would result in a basic EPS of $1.4 million ÷ 230,000, or $6.09.
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