Basic Earnings Per Share (EPS)
Earnings per share (EPS) is a financial indicator equal to the ratio of the company's net profit available for distribution to the average annual number of common shares. It is one of the key indicators that is used to compare the investment attractiveness and performance of companies operating in the stock market. Basic earnings per share is one of the EPS types, as opposed to the diluted earnings per share.
What Are Basic Earnings Per Share (EPS)?
It is the ratio of the company's net profit, after paying dividends on preferred shares for the reporting period, to the weighted average amount of common shares outstanding in the billing period.
Basic EPS shows the part of each common share in a company's financial results for a certain period. This indicator is used by analysts and investors to estimate potential income, which the owner of the stock can count on, as well as to evaluate company efficiency.
Shares are included in the calculation of the weighted average amount after the estimated compensation is determined.
For example, the shares can be issued:
in exchange for cash at the moment of debt recognition,
to pay for the asset at the time the asset is accounted for,
in exchange for interest payments at the moment the interest charges stop,
as part of the company acquisition.
The shares can be issued and withdrawn from circulation without changing the corresponding resource, for example, when splitting or consolidating shares.
Basic EPS Calculation
The basic earnings per share calculation formula are as follows:
Net Profit – Preferred Dividends / Weighted Average Common Shares.
In addition to net profit, the formula can use profit or loss from continuing operations, discontinued operations, and extraordinary items. When using these indicators, the above formula should be modified, that is, the corresponding indicator should be substituted in the numerator. The denominator of the formula is substituted by the weighted average amount of CS outstanding during the reporting period.
Let's suppose that the company's net profit for the reporting year amounted to $15,000,000, and the dividends paid on preferred shares is $2,250,000.
At the beginning of the reporting year (January 1), 675,500 common shares were in circulation.
On March 13, 55,800 shares were issued.
On June 22, additional issues reached 30,000.
On September 7, the amount was 41,400.
On November 25, it was 37,500.
To calculate earnings per share, it is necessary to calculate the weighted average amount of CS in circulation, for which the calculation of the corresponding weighting factors is required.
The weighting factor from January 1 to March 12 (71 days), when there were 675,500 common shares in circulation, was 0.195 (71/365).
From March 13 to June 21 (101 days), the number was 731,300 (675,500 + 55,800). The weighting factor for this period amounted to 0.277 (101/365).
From June 22 to September 6 (77 days), the number was 761,300 (731,300 + 30,000), and the weighting factor for this period was 0.211 (101/365).
From September 7 to November 24 (79 days), the number was 802,700 (761,300+41,400). In this case, the weighting factor amounted to 0.216 (79/365).
From November 25 to December 31 (37 days), the number totaled 840,200 (802,700 + 37,500), and the weighting factor was 0.101 (37/365).
Thus, the weighted average amount of common shares in circulation in the reporting year will be:
675,500 * 0.195 + 731,300 * 0.277 + 761,300 * 0.211 + 802,700 * 0.216 + 840,200 * 0.101 = 753,170
Accordingly, EPS equals:
EPS = (15,000,000 – 2,250,000) / 753,170 = $16.93
Typically, financial reporting requirements oblige companies to disclose EPS for at least the current and past reporting periods. However, despite these requirements, companies still retain quite a lot of flexibility in reporting and disclosing quarterly earnings per share. There are several options for calculating EPS, depending on what will be substituted in the numerator of the above formula. Thus, companies can choose the calculation algorithm that is more profitable for them.
Standards for filing financial statements in various jurisdictions also impose disclosure requirements on earnings per share. In the United States, the Generally Accepted Accounting Principles (GAAP) allow for the inclusion of one-time events, such as the sale of a business unit, which can distort EPS. Therefore, US companies typically disclose EPS in accordance with GAAP separately and also provide information on EPS, which does not include one-time income and expenses. In turn, the International Financial Reporting Standards (IFRS) involve the disclosure of two EPS indicators: basic and diluted.