## What is EPS?

**Earnings Per Share (EPS)** is the ratio between the net profits generated by a company relative to each common share outstanding.

Conceptually, the EPS ratio measures the net earnings of a company attributable to common shareholders, expressed on a per share basis and after adjusting for preferred dividend issuances.

## How to Calculate EPS (Step-by-Step)

EPS stands for “earnings per share” and is used to determine how much of a company’s accounting profit is attributable to each common share outstanding.

A company’s net earnings can either be 1) reinvested into operations or 2) distributed to common shareholders in the form of dividend issuances

Ultimately, this allocation is a discretionary decision determined by the company’s management team and the board of directors, with the goal of maximizing shareholder value.

The retained earnings line item on the balance sheet is thus determined by taking the prior period balance and adding the current period net income, followed by subtracting any common and preferred dividend issuances.

There are two forms of earnings per share: 1) Basic EPS and 2) Diluted EPS.

**Basic Earnings Per Share**: The basic EPS is a company’s net income relative to each common share outstanding.**Diluted Earnings Per Share**: The diluted EPS is a company’s net income relative to each common share outstanding after adjusting for potentially dilutive securities (e.g. options, warrants, and convertibles).

## Earnings Per Share Formula (EPS)

The formula for calculating the earnings per share (EPS) is as follows.

**Earnings Per Share (EPS) =**(Net Income

**–**Preferred Dividends)

**÷**Weighted Average Common Shares Outstanding

**Net Income**: The net income, or the “bottom line”, is the after-tax residual profits generated by a company in a given period, once all operating and non-operating costs are deducted.**Preferred Dividends**: Preferred stockholders are of higher priority (in terms of liquidation preference) than common shareholders in a company’s capital structure. Since the EPS metric represents the earnings to common (not preferred) shareholders, we must deduct any dividend issuances to preferred stockholders.**Weighted Average Number of Common Shares Outstanding**: The shares outstanding of a company refers to the total number of units of ownership issued by the company to date, after subtracting the number of shares that were retired via stock repurchases. The weighted average—the average between the beginning and end of period balance—is used to align the timing mismatch between the numerator and denominator.

## Basic Earnings Per Share vs. Diluted Earnings Per Share

The difference between the basic earnings per share and diluted earnings per share is that the latter adjusts for the net impact from potentially dilutive securities.

The roll-forward schedule to calculate (and forecast) a company’s basic shares outstanding is the following:

**Ending Basic Shares Outstanding =**Beginning Balance

**+**New Stock Issuances

**–**Stock Buybacks

From that starting point, the diluted shares are determined by compiling a company’s potentially dilutive securities such as options, warrants, restricted stock units (RSUs), and convertible debt instruments.

The standard methodology for determining a company’s diluted shares outstanding is the treasury stock method (TSM):

**Step 1:**The treasury stock method (TSM) assumes that if an option tranche is “in-the-money”—i.e. current share price exceeds the strike price—the option (or related security) is executed. The intuition is that given the economic incentive, the option holder will likely exercise the option since it would be profitable to do so.**Step 2:**Once exercised, the proceeds received by the issuer are then assumed to be used to repurchase as many shares as plausible at the current market share price to partially offset the dilutive impact.**Step 3:**The net dilution, i.e. the new shares created post-adjustment for the repurchases, is added to the original share count.

While only the securities that are “in-the-money” were included in the past, the more conservative approach of including all (or most of) the dilutive securities is now common practice.

**Therefore, the potentially dilutive securities are assumed to be exercised, irrespective of whether they are “in-the-money” or “out-of-the-money”.**

The distinction between the basic and diluted EPS can be seen in their formulas:

**Basic**

**Earnings Per Share (EPS) =**(Net Income

**–**Preferred Dividends)

**÷**Weighted Average of Common Shares Outstanding

**Diluted Earnings Per Share (EPS)**= (Net Income

**–**Preferred Dividends)

**÷**Weighted Average of Diluted Common Shares Outstanding

Since the denominator is greater in the basic EPS, diluted EPS is always less than the basic EPS.