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Earnings per share (EPS) is a well-known financial metric that measures Net Income relative to the number of outstanding shares a company has. EPS is often used to compare one company to another.
EPS can be either basic or diluted. Basic EPS shows the portion of Net Income attributed to each outstanding share of common stock. Basic EPS does not consider any potential dilution of EPS from convertible securities, which can increase the number of shares. Basic EPS is widely used by analysts and investors.
Basic EPS is Income Available to Common Shareholders divided by the Weighted Average Number of Shares Outstanding.
Both cumulative preferred stock dividends that are accrued in that year and non-cumulative preferred dividends that are declared in that year are deducted from Net Income.
The Weighted Average Number of Shares Outstanding takes into account events like stock issuances, stock dividends, treasury stock repurchases, and stock splits. For stock issuances and stock repurchases, you prorate them according to when these occurred during the year. If 100 shares were issued on May 1, then they are prorated at 8 months out of 12 months or two-thirds. If a treasury stock repurchase occurred on July 1, then those are prorated at half.
For stock splits and stock dividends, these are counted as if they were there all year. That’s because these don’t actually affect the value of equity. They merely redistribute it.
Diluted EPS does consider this potential dilution of EPS from convertible securities. Diluted EPS shows what EPS would be if all convertible securities like stock options, convertible bonds, and convertible preferred stock were all converted to common stock.
Diluted EPS is calculated in case a company has a complex capital structure. If there are no dilutive securities, then Diluted EPS will equal Basic EPS. The most common dilutive securities are:
There are cases in which a convertible security is anti-dilutive, which means that if it were converted the earnings attributable to the convertible security are greater than the earnings that would be allocated to the additional common shares upon conversion. In these cases, anti-dilutive securities are removed from the calculation for Diluted EPS.
So, you need to assess for each class of convertible security whether it would be dilutive or anti-dilutive for this company based on its effect of Income Available to Common Shareholders and the Weighted Average Number of Outstanding Shares.
When convertible bonds convert to shares, there are two income effects: Interest savings and an increase in income tax from the loss of the interest deduction.
These income effects are compared to the effects of converting the bonds into shares.
When preferred shares are converted to common stock, the preferred dividend payable is added back to income.
The number of common shares from a preferred share depends on the company’s preferred share conversion ratio.
These do not affect the income part of the EPS ratio. They do however provide the company with cash from their exercise. To calculate the increase in common stock, presume that the company will use all of these proceeds to reacquire treasury stock. So, the increase in common stock is equal to the number of options. Then deduct the amount of repurchases that could fund.
Companies are typically required by GAAP to report both Basic EPS and Diluted EPS. The following table summarizes these requirements.
| Income from Continuing Operations | Disclose both Basic and Diluted EPS on the face of the Income Statement for Income from Continuing Operations |
| Net Income | Disclose both Basic and Diluted EPS on the face of the Income Statement for Net Income |
| Income from Discontinued Operations | Disclose both Basic and Diluted EPS either on the face or in the notes for Income from Discontinued Operations |
| Reconcile the numerator and denominator | Reconcile the numerator and denominator of the Basic and Diluted EPS for Income from Discontinued Operations to show the effects of each class of convertible securities. |
| Potentially Dilutive Securities | Disclose the potentially dilutive securities that were not included in the calculation of Diluted EPS because they were antidilutive. |
| Method used | Disclose the method used in the Diluted EPS computation for each class of dilutive convertible security |
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Hi there! I'm Matt. I'm a Christian, husband and father of four. I'm a graduate of Calvin, Harvard, Cardiff and Johns Hopkins Universities. I have a PhD in Economics, an MBA in Finance and an MS in Data Analytics. I'm a numbers guy who can communicate well!
I began this service to work directly with the small and mid-sized business owners who grow our great country's economy. Since 1999, I've worked with owners across industries from high tech IT and robotics to small farmers and artists. I've also helped and advised nonprofits from churches to civic organizations.
I also served as a Finance Staff Officer and eventually as the National Division Chief for Measurement Research within the US Coast Guard. The research and methods I created there continue to guide strategic decisions to this day.
I enjoy being active outdoors, especially in wild lands. Hiking, biking and fly fishing are some of my favorite pastimes.
I also love dogs! I'm an AKC obedience evaluator, and I train service and therapy dogs.
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Earnings per share (EPS) is a well-known financial metric that measures Net Income relative to the number of outstanding shares a company has. EPS is often used to compare one company to another. Basic Earnings Per Share EPS can be either basic or diluted. Basic EPS shows the portion of Net Income attributed to each […]
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