Basic earnings per share

Definition

Basic earnings per share (EPS) is a financial metric that indicates the amount of net income earned for each outstanding share of common stock. This calculation provides investors with an insight into a company's profitability on a per-share basis, which is essential for evaluating its financial performance. The basic EPS is derived from the company's net income, adjusted for dividends on preferred stock, divided by the weighted average number of common shares outstanding during a specific period.

5 Must Know Facts For Your Next Test

1. Basic EPS is calculated using the formula: $$\text{Basic EPS} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Shares Outstanding}}$$.
2. The weighted average number of shares includes adjustments for stock splits and new issuances, reflecting changes in the number of shares throughout the reporting period.
3. Basic EPS does not take into account potential dilution from convertible securities, options, or warrants, which is why diluted EPS is also calculated.
4. A higher basic EPS indicates better profitability and is generally viewed positively by investors and analysts when comparing companies within the same industry.
5. Basic EPS can be found on a company's income statement and is often reported alongside diluted EPS for clarity on earnings performance.

Review Questions

• How do you calculate basic earnings per share and what components are involved in this calculation?
  • To calculate basic earnings per share (EPS), you need to take the net income and subtract any preferred dividends, then divide this result by the weighted average number of common shares outstanding. This formula gives you an insight into how much profit was generated per share of common stock. The components involved include net income, preferred dividends, and the weighted average shares, which reflect any changes in share count during the period.
• Discuss how the weighted average number of shares impacts the calculation of basic earnings per share.
  • The weighted average number of shares plays a crucial role in calculating basic earnings per share because it ensures that the EPS reflects changes in the number of outstanding shares throughout the reporting period. If a company issues new shares or has stock splits during the period, these factors are accounted for in the weighted average calculation. This helps provide a more accurate representation of earnings available to each shareholder and allows for meaningful comparisons across different time periods.
• Evaluate how basic earnings per share can influence investment decisions and compare it with diluted earnings per share.
  • Basic earnings per share serves as a key indicator for investors assessing a company's profitability on a per-share basis. It can greatly influence investment decisions as investors often look for companies with high EPS as it indicates strong performance. However, comparing basic EPS to diluted EPS is important as diluted EPS considers potential dilution from convertible securities and stock options. Analyzing both metrics gives investors a fuller picture of potential future earnings performance and helps them make more informed investment choices.

Related terms

net income: Net income is the total profit of a company after all expenses, taxes, and costs have been subtracted from total revenue.

dividends: Dividends are payments made by a corporation to its shareholders, typically derived from the company's profits, and can be in the form of cash or additional shares.

weighted average number of shares: The weighted average number of shares is a calculation used to determine the average number of shares outstanding over a specific period, accounting for any stock splits or new issuances.