Accounting

Earnings Per Share (EPS)

Guide to Understanding Earnings Per Share (EPS)

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.

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How Stock Buybacks and New Stock Issuances Impact EPS

New stock issuances and stock buybacks are two methods for publicly-traded companies to directly impact their number of outstanding shares.

New Stock Issuances: Public companies can raise more capital through equity issuances. But since more shares are issued in exchange for capital, there are more shares in circulation, resulting in more dilution. Thus, the company’s earnings per share (EPS) declines in value since the ratio’s denominator has increased.
Stock Buybacks: In contrast, stock buybacks reduce the number of shares outstanding and increase the proportion of earnings that each common share is entitled to. Stock buybacks have become increasingly prevalent in lieu of dividends due to the resulting positive market signal sent out to investors, i.e. it may imply that management believes the current share price is undervalued.

With regard to the impact on earnings per share, new stock issuances cause a company’s EPS to decline, whereas stock buybacks result in an artificially higher EPS.

Learn More → How Share Repurchases Boost Earnings Without Improving Returns (Source: McKinsey)

Shares Outstanding: Stock Split and Reverse Stock Split

Aside from new issuances and buybacks, public companies can also impact their share count through stock splits and reverse stock splits.

Stock Split: A stock split occurs when a company decides to divide each share into a pre-determined number of shares. For instance, a company’s share count would double in a 2-1 stock split, while its share price trades at half of its former price.
Reverse Stock Split: A reverse stock split achieves the opposite effect as a stock split. If the company orders a 1-2 reverse split, the number of shares outstanding would be cut in half, while its share price would double.

The market capitalization, i.e. “equity value”, of a company following a stock split or reverse stock split should be neutral in theory.

But in actuality, stock splits and reverse splits can still affect a company’s share price, which depends on the market’s perception of the decision.

How to Find EPS on Income Statement

Earnings Per Share Example: Apple (AAPL)

The earnings per share (EPS) reported by a company per GAAP accounting standards can be found near the bottom of a company’s income statement, right below net income.

The section will contain the EPS figures on a basic and diluted basis, as well as the share counts used to compute the EPS.

The screenshot below is of the income statement of Apple (AAPL) from its 10-K filings for fiscal year ending 2022.

^{Apple Earnings Per Share, Fiscal Year 2022 (Source: AAPL 10-K)}

EPS Calculator – Excel Model Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

Step 1. Income Statement Assumptions

Suppose we’re tasked with calculating the earnings per share (EPS) of a company that reported $250 million in net income for fiscal year 2021.

Of the $250 million in net earnings, $25 million was issued to preferred shareholders in the form of a dividend.

Net Income = $250 million
Preferred Dividend = $25 million

Thus, the “Net Earnings for Common Equity”—which is calculated by deducting the preferred dividend from net income—amounts to $225 million.

Net Earnings for Common Equity = $250 million –$25 million = $225 million

The number of common shares outstanding at the beginning of the period was 160 million.

Throughout fiscal year 2021, the company issued no new shares and repurchased 20 million shares, resulting in 140 million common shares outstanding at the end of the period.

Ending Common Shares Outstanding = 160 million + 0 million – 20 million = 140 million

Step 2. Basic Earnings Per Share Calculation Example

Since we now have the beginning and ending number of common shares outstanding, the next step is to calculate the weighted average shares outstanding.

Weighted Average Shares Outstanding = (160 million + 140 million) ÷ 2 = 150 million

For the sake of simplicity, we’ll assume the date on which the buyback occurred is right in the middle of the fiscal year, i.e. two quarters with 160 million shares and two quarters with 140 million shares outstanding.

We now have the necessary inputs to calculate the basic EPS, so we’ll divide the net earnings for common equity by the weighted average shares outstanding.

Basic EPS = $225 million ÷ 150 million = $1.50

Our company’s basic earnings per share (EPS) comes out to be $1.50.

Step 3. Diluted Earnings Per Share Calculation Example

In the next part of our exercise, we’ll determine our company’s diluted earnings per share (EPS).

The treasury stock method (TSM) requires the market share price, which we’ll assume is $40.00 as of the latest market closing date.

Market Share Price = $40.00

The table below outlines the dilutive securities issued by our company.

Options Table	Shares (#)	Strike ($)	Net Impact (#)
Tranche 1	10 million	$5.00	9 million
Tranche 2	15 million	$10.00	11 million
Tranche 3	20 million	$20.00	10 million
Net Dilutive Impact			30 million

The net dilution equals the gross new shares in each tranche less the shares repurchased.

Net Dilution = Gross “In-the-Money” Dilutive Securities – Shares Repurchased

The number of shares repurchased is calculated by taking the strike price multiplied by the new shares—divided by the market share price.

The net dilution comes out to be 30 million shares, which we’ll add to the weighted average shares outstanding of 150 million.

On a fully diluted basis, our company has a total of 180 million shares outstanding.

Net Dilution = 9 million +11 million +10 million = 30 million
Fully Diluted Shares Outstanding = 150 million + 30 million = 180 million

In the final step, we arrive at a diluted earnings per share (EPS) of $1.25 upon dividing our company’s net earnings to common by the fully diluted share count, reflecting a difference of $0.25 per share relative to the basic EPS.

Diluted Earnings Per Share (EPS) = $225 million ÷ 180 million = $1.25

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