How to Determine Earnings Per Share (Basic and Diluted)

Earnings Per Share (EPS) is a widely recognized financial metric providing insights into a company’s profitability from a common shareholder’s perspective. It represents the portion of a company’s profit allocated to each outstanding share of common stock. Investors and analysts utilize EPS to gauge a company’s financial health and performance. A higher EPS often indicates a greater return for each share, which can make a company more appealing to investors. This metric links a company’s net income and the value attributed to its individual shares.

Understanding Earnings Per Share

EPS plays a significant role for investors and financial analysts as a clear indicator of a company’s profitability and overall value. It helps assess how much profit a company generates for each share of its stock. A fundamental distinction exists between “basic” EPS and “diluted” EPS, providing different perspectives. Basic EPS reflects earnings based on the current number of shares outstanding.

Diluted EPS provides a more conservative view by accounting for potential future shares that could be issued, which would reduce the earnings attributed to each existing share. The numerator for EPS calculations, “net income available to common shareholders,” is derived after deducting preferred dividends from the company’s total net income. This ensures earnings attributed to common stock reflect profit remaining after preferred shareholder obligations. The denominator is the total number of a company’s shares held by investors.

Basic Earnings Per Share Calculation

Basic Earnings Per Share is calculated by dividing the net income available to common shareholders by the weighted average common shares outstanding. This provides a direct measure of the profit attributable to each share held by common stockholders.

The numerator, “Net Income Available to Common Shareholders,” is the company’s net income minus any preferred dividends. Preferred dividends are payments to preferred shareholders, who typically have a fixed dividend rate and a higher claim on a company’s earnings. For cumulative preferred shares, current and any unpaid prior dividends (dividends in arrears) must be deducted, regardless of declaration. For non-cumulative preferred shares, only declared dividends for the current period are subtracted. This ensures only profit truly available to common shareholders is considered.

The denominator, “Weighted Average Common Shares Outstanding (WASO),” is a dynamic figure reflecting changes in the number of shares throughout the reporting period. Since common shares fluctuate due to new issuances, share repurchases, or stock splits, WASO weights each change by the portion of the reporting period it was outstanding. For instance, if additional shares were issued halfway through the year, those new shares are counted for half the year in the weighted average. Stock splits and stock dividends are treated as if they occurred at the beginning of the earliest period presented, requiring a retroactive adjustment to the share count for all periods. This weighting process ensures the denominator aligns with the income generated over the entire reporting period.

Diluted Earnings Per Share Calculation

Diluted Earnings Per Share (EPS) offers a more conservative perspective on a company’s profitability by considering the potential impact of all securities that could be converted into common stock. This calculation illustrates what the EPS would be if all such convertible securities were exercised or converted, increasing the number of outstanding common shares. Diluted EPS will always be less than or equal to basic EPS, as the potential increase in the share count can only reduce or maintain the per-share earnings.

Several types of securities can lead to dilution. These include stock options and warrants, which grant holders the right to purchase common stock at a specified price; convertible bonds, which are debt instruments exchangeable for a predetermined number of common shares; and convertible preferred stock, which can also be converted into common shares. When these securities are converted, they increase the total number of common shares, potentially reducing the earnings per share for existing shareholders.

The calculation of diluted EPS incorporates these potential conversions. For stock options and warrants, the Treasury Stock Method assumes that proceeds from the exercise of “in-the-money” options would be used to repurchase shares in the open market. The net increase in shares, after accounting for these repurchases, is then added to the weighted average common shares outstanding. For convertible bonds and convertible preferred stock, the If-Converted Method is used. This method assumes these securities were converted into common stock at the beginning of the reporting period. Under this method, the numerator (net income available to common shareholders) is adjusted by adding back any interest expense (net of tax) saved on converted debt or preferred dividends that would no longer be paid. The denominator is increased by the number of common shares that would be issued upon conversion.

Sourcing Required Information

To accurately calculate both basic and diluted earnings per share, specific financial data must be sourced from a company’s official financial statements. Net income, the starting point for the numerator, is readily available on the company’s income statement, which summarizes revenues, expenses, and profits.

Information regarding common shares outstanding and changes (issuances, repurchases) can be found in several places. The balance sheet provides a snapshot of shares outstanding. For a comprehensive view of share movements, the statement of changes in equity or the shareholder’s equity section of the balance sheet offers more detailed insights.

The notes to the financial statements are an important resource for obtaining details needed for accurate EPS calculations. These notes provide information on preferred dividends (cumulative or non-cumulative) and disclosures related to potentially dilutive securities like stock options, warrants, convertible bonds, and convertible preferred stock, outlining their terms and impact. Companies often report their own calculated basic and diluted EPS figures, along with weighted average share counts, within these notes. For public companies, these audited financial statements are typically accessible through the SEC’s EDGAR database (10-K or 10-Q reports).