What it means
Profit on its own says nothing about what a shareholder actually owns a slice of. A company earning $50,000,000 with 10,000,000 shares in issue is in a very different position from one earning the same amount across 500,000,000 shares, and the ratio makes that difference immediately visible.
The numerator is profit after tax attributable to ordinary shareholders, which means any dividends due to preference shareholders are stripped out first. Preference shareholders have a prior claim on profit, so leaving their dividends in would overstate what is genuinely available to ordinary shareholders.
The denominator is the weighted average number of ordinary shares, not the count on the last day of the year. Shares issued halfway through the period only contributed to earnings for half of it, so weighting keeps the ratio honest when a company has raised equity or bought shares back.
The ratio is used as a building block rather than as a verdict. It feeds the price to earnings ratio that investors use to compare valuations, it often sets the threshold for executive share awards, and its growth rate is watched more closely than its absolute level.
The important caveat is that basic earnings per share can be flattered by actions that create no value at all. A large share buyback reduces the share count and lifts the ratio even if profit is flat, which is why analysts read it alongside revenue growth, cash generation and the diluted version of the same number.
In practice
Real-world examples.
Example
A food producer reports flat profit but a basic earnings per share figure 8% higher than last year. The improvement comes entirely from a buyback that reduced the average share count, so the board is asked to explain why underlying trading did not move.
Example
A biotechnology company records a loss and reports basic earnings per share of -$0.42. The negative figure is still calculated the same way, and investors use it to judge how much cash each share is consuming per year.
Example
A family owned printer preparing for sale calculates basic earnings per share for the first time and finds it makes the valuation conversation far easier. The buyer's offer is framed as a multiple of that per share figure rather than as a lump sum.
Think of it
“Basic EPS is earnings per share using current shares only-not counting options or convertibles.
Formula
Calculation
Basic earnings per share = (profit after tax - preference dividends) / weighted average number of ordinary shares
A listed engineering group reports profit after tax of $12,600,000 and pays $600,000 of preference dividends. Earnings attributable to ordinary shareholders are $12,600,000 - $600,000 = $12,000,000.
The weighted average number of ordinary shares over the year was 20,000,000, so basic earnings per share is $12,000,000 / 20,000,000 = $0.60 per share. With the shares trading at $9.00, the price to earnings ratio is $9.00 / $0.60 = 15, meaning investors are paying fifteen times current annual earnings for each share.Case study
Seen in the real world.
The following is an illustrative and fictional example. Corriedale Packaging, an invented listed manufacturer, tied a large part of its executive bonus scheme to growth in basic earnings per share and nothing else. Over three years the ratio grew by roughly 9% a year and the bonuses were paid in full each time.
A fictional analyst then rebuilt the numbers and showed that profit had been almost unchanged across the period. All of the per share growth came from buying back shares with borrowed money, which had lifted the ratio while quietly raising interest costs and gearing.
Corriedale's remuneration committee revised the scheme to require earnings per share growth alongside a return on capital test, on the reasoning that a measure worth rewarding should be one that cannot be improved simply by changing the denominator.
Watch out
Common mistakes.
- Dividing profit by the year end share count instead of the weighted average, which distorts the ratio in any year with an issue or buyback.
- Forgetting to deduct preference dividends, which overstates the earnings genuinely attributable to ordinary shareholders.
- Comparing the ratio between two companies as though it measured size or quality, when share counts are arbitrary and only the trend and the multiple mean much.
Questions
People also ask.
Why does the basic version exist if diluted is more conservative?
Basic shows what actually happened during the year, while diluted shows what would happen if all potential shares converted, and readers benefit from seeing both.
Can this ratio be negative?
Yes, a loss making company reports a negative figure, which is often described as a loss per share.
Does a rising ratio always mean a better business?
No, it can rise through buybacks, disposals or one off gains, so it should be read next to cash flow and revenue.
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