What it means
A company's share count rarely stays the same for a full year. It may issue new shares to raise money, pay staff in shares, or buy shares back, and each of these changes affects how profit is spread across owners.
Suppose a company issues a large number of shares in the last week of the year. The new money has hardly had time to earn anything, so dividing the full year's profit by the year-end count would understate earnings per share.
The weighted average solves this by giving each share only the weight of the time it was in issue. To calculate it, you multiply each share count by the fraction of the period it was outstanding and add the results.
Shares issued mid-year count for part of the year, and shares bought back stop counting from the date of repurchase. Stock splits and stock dividends are treated differently.
Because they change the number of shares without changing the value of the business, they are applied as if they had happened at the start of the period, and prior periods are restated to match. Weighted average shares feed directly into basic earnings per share, and a similar figure that includes potential new shares, such as options and convertible bonds, is used for diluted earnings per share.
Investors compare these ratios across companies and over time, so accuracy matters. Analysts use the figure to judge whether growth in profit is real growth per share or merely the result of spreading profit across more shares.
A company that grows total profit while its share count rises faster is not improving returns for each owner.
In practice
Real-world examples
Example 1
A technology company issues 500,000 new shares on 1 July to fund an acquisition. Because the shares were outstanding for only half the year, the weighted average includes 250,000 of them. Earnings per share therefore reflects the part-year contribution of the new money.
Example 2
A retailer repurchases 200,000 shares on 1 September, four months before year end. The buyback reduces the weighted average count by 200,000 x 4/12, which is about 66,667 shares. Earnings per share rises slightly as a result.
Example 3
A manufacturer completes a two-for-one stock split in November. The split is applied as if it had occurred at the start of the year, so the weighted average count doubles for the whole year. Last year's share count and earnings per share are restated to match.
Think of it
Imagine calculating the average temperature of a swimming pool over a day. A reading at sunrise and sunset is not enough; you must weigh the hours of freezing morning water against the warm afternoon sun to get an accurate daily average.
Formula
Calculation
Weighted average shares = Sum of (Shares outstanding x Fraction of the period outstanding)
Basic earnings per share = Net income available to ordinary shareholders / Weighted average shares
A company starts the year with 1,000,000 shares. On 1 April it issues 240,000 new shares, which are outstanding for 9 of the 12 months. On 1 October it buys back 120,000 shares, which reduces the count for the last 3 months. Weighted average = 1,000,000 + (240,000 x 9/12) - (120,000 x 3/12) = 1,000,000 + 180,000 - 30,000 = 1,150,000. With net income of $2,300,000, basic earnings per share = 2,300,000 / 1,150,000 = $2.00. The year-end count of 1,120,000 would have given $2.05, which overstates earnings per share.Case study
Seen in the real world
Falconridge Systems is an illustrative, fictional software company with 4,000,000 shares at the start of the year. It issued 1,200,000 shares on 1 February to fund a product launch, then reported net income of $5,200,000.
The new shares were outstanding for 11 of the 12 months, so the weighted average was 4,000,000 + 1,200,000 x 11/12 = 4,000,000 + 1,100,000 = 5,100,000. Basic earnings per share = 5,200,000 / 5,100,000 = $1.02 to the nearest cent.
An analyst who used the year-end count of 5,200,000 would have calculated $1.00. In the illustrative case, the board used the weighted figure in its report, and shareholders could see that the new shares had been in issue for almost the whole year.
Watch out
Common mistakes
- Using the year-end share count to calculate earnings per share, which ignores when shares were actually issued or repurchased.
- Forgetting that buybacks reduce the weighted average only from the date of repurchase.
- Applying stock splits from the date they occurred, when they should be applied to the whole period and to comparative figures.
Questions
People also ask
Why is a weighted average used rather than a simple average?
A weighted average accounts for how long each share count was in place, so a share issued late in the year counts for less than one in issue all year.
How do options and convertible securities affect the figure?
They do not change basic weighted average shares until exercised or converted, but they are included in the diluted calculation if they would reduce earnings per share.
Which period fractions should be used?
Months or days can both be used, and the key is to apply the same method consistently.