Earnings Per Share

Earnings per share (EPS) is the portion of a company's profit over a reporting period allocated to each share of common stock outstanding on a time-weighted basis over that same period. EPS serves as an indicator of a company's profitability and is calculated as follows for any financial reporting period:

EPS = Net Earnings Available to Common Shareholders / Weighted-Average Shares Outstanding

The Importance of EPS

EPS is an important metric that investors use to assess a company’s financial performance and equity valuation. It is also used to calculate the commonly-used price-to-earnings (P/E) valuation ratio. By dividing a company's share price by its earnings per share, an investor can understand the value of a stock in terms of what the market is willing to pay for a dollar of the company's earnings.

EPS is an important fundamental metric because it breaks down a firm's profits on a per share basis. This is especially important because the number of shares outstanding (i.e. that share in the earnings) could change over time – this means that the aggregate amount of earnings of a company on its own is not a good measure of financial performance.

Different Types of EPS

Companies need to report both basic and diluted EPS for all financial periods appearing on the income statement. Basic EPS uses the actual weighted-average number of shares outstanding during the period, whereas Diluted EPS considers the hypothetical impact of the conversion of any dilutive securities that are convertible into common stock. Dilutive securities could include warrants, stock options, convertible bonds or preferred stock.

Basic EPS

Basic EPS does not consider the effect of any securities that can convert into more common shares and add to the total number of shares outstanding (“dilutive” securities). Basic EPS simply uses the company’s reported net earnings available to common shareholders in the numerator, and the weighted-average number of common shares outstanding during the period in the denominator:

Basic Earnings per Share

Note that if the company has preferred shares, dividends on these shares will be subtracted from net earnings because EPS refers to earnings available to common shareholders. However, common share dividends are not subtracted from net earnings in the EPS calculation.

Example: Apple’s Net Income attributable to Common Shareholders for fiscal 2018 was $59.5 billion and the basic weighted average common shares outstanding was 4.955 billion. Therefore, basic EPS for Apple in 2018 was $59.5 / 4.955 = $12.01 / share as shown below:

Consolidated Statements of Operation EPS

Diluted EPS

Diluted EPS is a hypothetical calculation that shows the impact on EPS if all securities that would lower earnings per share were converted into common stock (such as stock options, warrants, etc.) and added to the total number of shares outstanding. Under most circumstances, research analysts will forecast diluted EPS. Similarly, it’s most common to use diluted EPS as opposed to basic EPS when doing comparables analysis.

Dilutive securities are those that (i) can be converted to common stock if the holder exercises their option, and (ii) would reduce EPS if the holder of the security converted their security into common stock.

To calculate diluted EPS, two adjustments need to be made:

    • Increase the weighted average number of shares outstanding assuming dilution occurred at the beginning of the financial reporting period; and
    • If needed, adjust net income to common shareholders to give pro forma effect to the conversion into common shares – for example, if the convertible preferred shares are dilutive, we would need to add back any preferred dividend to net income.

In the example below, we see that an extra 44.732 mm shares are included in Apple’s diluted share count but there is no adjustment to net income:

Diluted Earnings Per Share

Dilutive Securities

Dilutive securities are those that (i) can be converted to common stock if the holder exercises their option, and (ii) would reduce EPS if the holder of the security converted their security into common stock.

Examples of dilutive securities include stock options, warrants, restricted stock units (RSUs), convertible debt, and convertible preferred shares are common types of dilutive securities:

  • Stock options and warrants grant the holder the right to purchase common stock at a set price for a set time.
  • Restricted stock units grant the holder common shares when they vest.
  • Convertible debt allows the holders and/or issuer to convert the debt into a specified number of common shares at specific times.
  • Convertible preferred shares allow the holders and/or issuer to convert the preferred equity into a specified number of common shares at specific times.

Weighted-Average Shares Outstanding and EPS

The weighted-average number of shares is used in EPS calculations to match the fact that the income in the numerator is earned over the reporting period. In other words, a common share only begins to share in the earnings of a company on the day it becomes outstanding. By the same token, a share that is repurchased ceases to participate in the earnings on the day it is bought back by the company. Because of the detail needed to calculate weighted average shares outstanding, companies provide this number and publish it in their financial statements and notes.

How to Calculate Weighted-Average Shares Outstanding

There are three steps to calculate the weighted average number of common shares outstanding:

Step 1 – Compute the number of shares outstanding after each change in the common shares. An issuance of new shares increases the number of shares outstanding whereas a repurchase of shares reduces the number of shares outstanding.

Step 2 – Weight the shares outstanding by the portion of the year between one change and the next change. Weight = days outstanding / 365 = Months outstanding / 12

Step 3 – Sum up to compute the weighted average number of common shares outstanding. Note that the weighted average share amounts, both basic and diluted, are typically disclosed either directly on the income statement, or in the notes and/or MD&A. The implied number of shares can also be calculated by dividing net earnings by the EPS.

The Effect of Stock Dividends and Stock Splits on EPS

When a stock dividend or split occurs, calculating the weighted average number of shares requires restatement of the shares outstanding before the stock dividend or split. It is not weighted by the portion of the year after the stock dividend or split occurred.

If a stock dividend or split occurs after the end of the year, but before the financial statements are issued, the weighted average number of shares outstanding for the year (and any other years presented in comparative form) must be restated.

Anti-Dilutive Securities and EPS

An anti-dilutive security is one that causes the earnings per share to INCREASE or the loss per share to DECREASE. Some potentially convertible securities are anti-dilutive which means that their inclusion in the EPS calculation would result in an EPS which is higher than the company’s basic EPS. Under both IFRS and US GAAP, however, these anti-dilutive securities are excluded from the calculation of diluted EPS. In other words, as a rule diluted EPS should always be less than or equal to basic EPS, and should reflect the maximum potential dilution from the conversion of potentially dilutive financial instruments. Diluted EPS is a potential worst-case scenario and hence cannot be higher than basic EPS.