How to Calculate Basic Earnings Per Share
Unravel the process of calculating Basic Earnings Per Share to gain clear insight into a company's core profitability.
Earnings Per Share (EPS) is a financial metric that provides a standardized view of a company’s profitability. It represents the portion of a company’s profit allocated to each outstanding share of common stock. This figure is widely utilized by investors and financial analysts to assess a company’s financial health, evaluate its performance, and estimate the potential value of its shares.
Understanding Basic Earnings Per Share
Basic Earnings Per Share defines the portion of a company’s profit attributed to each outstanding common share. It serves as an indicator for investors, allowing them to compare the profitability of different companies, regardless of their size. A higher Basic EPS suggests a more profitable company and indicates that more profits are available for distribution to its shareholders. This metric is useful in fundamental analysis, often forming a component of valuation ratios like the price-to-earnings (P/E) ratio, which helps investors gauge if a stock is fairly priced based on its earnings.
Identifying the Necessary Financial Data
Calculating Basic EPS requires specific financial figures, primarily sourced from a company’s financial statements. The first component is net income, also known as net profit or earnings. This figure represents the company’s total profit after all expenses, including operating costs, interest, and taxes, have been deducted from its revenues. Net income is found as the “bottom line” on the company’s income statement.
Preferred dividends are another component. Preferred shareholders have a claim on a company’s earnings that takes precedence over common shareholders. Therefore, any dividends paid or due to preferred shareholders must be subtracted from net income to determine the earnings available to common shareholders. Information regarding preferred dividends can be found in the income statement or within the footnotes to the financial statements.
The final piece of data needed is the weighted-average common shares outstanding. These are the number of common shares held by investors, excluding treasury stock, averaged over the reporting period. This figure is disclosed in the balance sheet, the statement of changes in equity, or within the footnotes to the financial statements. Using a weighted average is important because the number of shares can fluctuate throughout the year due to various corporate actions, which a simple year-end count would not accurately reflect.
Performing the Basic EPS Calculation
The formula for Basic EPS is: (Net Income – Preferred Dividends) / Weighted-Average Common Shares Outstanding. This calculation determines the earnings attributable to each share of common stock.
The first step in the calculation is to determine the “earnings available to common shareholders.” This is achieved by subtracting the total preferred dividends from the company’s net income. For instance, if a company reports a net income of $1,000,000 and has preferred dividends of $100,000, the earnings available to common shareholders would be $900,000.
The second step involves identifying the weighted-average number of common shares outstanding for the reporting period. If, in the same example, the weighted-average common shares outstanding were 500,000, this number forms the denominator of the EPS formula. The final step is to divide the earnings available to common shareholders by the weighted-average common shares outstanding. Continuing the example, $900,000 divided by 500,000 shares results in a Basic EPS of $1.80 per share.
Adjusting the Share Count
Accurately determining the denominator for the Basic EPS calculation, the weighted-average common shares outstanding, requires careful consideration of changes in a company’s share count over time. A simple count of shares at the end of a period is insufficient because the number of shares can fluctuate throughout the year. A weighted average accounts for the duration each block of shares was outstanding during the reporting period, providing a more precise reflection of the average number of shares that participated in generating the reported earnings.
Corporate actions such as stock splits and stock dividends impact the share count. These events increase the number of shares without affecting the company’s total equity. For EPS calculation purposes, stock splits and stock dividends are treated as if they occurred at the beginning of the earliest period presented in the financial statements. This retroactive adjustment ensures comparability of EPS figures across different reporting periods.
Share issuances and repurchases also influence the weighted-average share count. When a company issues new shares, these shares are included in the weighted average from their date of issuance. Conversely, when a company repurchases its own shares (known as treasury stock), these shares are excluded from the weighted average from the date of repurchase. These adjustments ensure that the denominator accurately reflects the shares that were outstanding and eligible to earn income during the period.