What it means
Basic earnings per share turns a total profit figure into a per-share amount so that companies of different sizes can be compared on a like-for-like basis. Profit of $12,000,000 tells you nothing about whether the shares are cheap until you know how many shares that profit is spread across.
Two adjustments make the calculation less obvious than it looks. Dividends due to preference shareholders are deducted first, because that portion of profit belongs to them rather than to ordinary shareholders, and the share count is weighted by how long each share was actually in issue.
The weighting matters whenever a company issues or buys back shares mid-year. Shares issued halfway through the year only count for half a year, which prevents a late fundraising from artificially depressing the earnings figure for the whole period.
Business readers meet this number most often as the denominator of the price to earnings ratio, and as the headline in results announcements. Because so much attention is paid to it, management teams are acutely aware that share buybacks raise earnings per share even when profit is flat.
The important variant is diluted earnings per share, which recalculates the figure as though every option, convertible instrument and contingent share had already been converted. Diluted is always equal to or lower than basic, and the gap between the two shows how much existing shareholders could be watered down.
In practice
Real-world examples.
Example
A listed retailer reports net income of $45,000,000 on a weighted average of 30,000,000 shares, giving basic EPS of $1.50. With the shares trading at $22.50, analysts immediately read the price to earnings ratio as 15 times.
Example
A manufacturer buys back 10% of its shares during a flat year. Profit is unchanged but basic EPS rises about 5% because the buyback happened in July and only affects half the weighted average, a nuance the chief executive is careful to explain in the results call.
Example
A technology company reports basic EPS of $0.80 and diluted EPS of $0.68 because of a large pool of employee share options. An investor treats the 15% gap as the real cost of the company's equity compensation.
Formula
Calculation
Basic EPS = (net income - preference dividends) / weighted average number of ordinary shares outstanding. Take a company reporting net income of $12,400,000 for the year with preference dividends of $400,000, leaving $12,400,000 - $400,000 = $12,000,000 available to ordinary shareholders. The company began the year with 5,000,000 ordinary shares and issued a further 2,000,000 on 1 July, exactly halfway through the year, so those new shares count as 2,000,000 x 6/12 = 1,000,000 and the weighted average is 5,000,000 + 1,000,000 = 6,000,000 shares. Basic EPS is therefore $12,000,000 / 6,000,000 = $2.00 per share. Had the company simply used the 7,000,000 shares in issue at the year end, EPS would have looked like $12,000,000 / 7,000,000 = $1.71, understating the result by 29 cents.Case study
Seen in the real world.
The following is an illustrative, fictional example. Brackenhill Instruments, an invented listed engineering group, raised $30,000,000 through a share placing in October to fund a factory expansion, issuing 2,000,000 new shares on top of the 5,000,000 already in issue.
In the illustrative scenario, the finance team's first draft of the annual results divided $12,000,000 of full-year earnings by the 7,000,000 shares outstanding at 31 December, producing an EPS of $1.71 and a story about earnings falling sharply. The auditors corrected the approach: the new shares had only been in issue for three months, so they counted as 2,000,000 x 3/12 = 500,000, giving a weighted average of 5,500,000 and an EPS of $12,000,000 / 5,500,000 = $2.18.
The fictional lesson is that the share count is a timing calculation, not a year-end snapshot. Getting it wrong would have handed the market a 22% earnings decline that never actually happened.
Watch out
Common mistakes.
- Using the share count at the year end rather than the weighted average, which distorts the figure badly whenever shares were issued or bought back during the year.
- Forgetting to deduct preference dividends, which overstates the earnings genuinely attributable to ordinary shareholders.
- Reading rising earnings per share as rising profit, when a share buyback can lift the figure while profit stands still or even falls.
Questions
People also ask.
What is the difference between basic and diluted EPS?
Basic uses only the shares actually in issue, while diluted assumes every option and convertible instrument has been exercised, so diluted is always the same as or lower than basic.
Does a higher EPS mean a better investment?
Not on its own, because EPS depends on how many shares exist rather than on business quality, so it only becomes meaningful when compared with the share price or tracked over several years.
Why are preference dividends subtracted?
Because preference shareholders have a prior claim on profit, so that portion is not available to ordinary shareholders and should not be counted in their per-share earnings.
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