What you will learn
- Calculate basic earnings per share
- Explain why preferred dividends are subtracted first
- Tell the difference between basic and diluted EPS
- Recognize how share buybacks can raise EPS without more profit
Total net income is a company-wide figure, but as a shareholder you own a slice, not the whole pie. Earnings per share, or EPS, translates the whole company's profit into a per-share number. It is the bridge between a company's bottom line and what each individual share has earned, and it is the single number markets react to most each earnings season.
EPS (earnings per share) explained (Edspira)
A professor's clear definition of EPS and why it matters. Watch this before the calculation below.
The basic calculation
EPS equals net income, minus any dividends owed to preferred shareholders, divided by the number of common shares outstanding. The preferred dividends are subtracted because that profit belongs to preferred holders, not common shareholders. The share count is usually the weighted average over the period, because the number of shares can change during the year as a company issues or buys back stock.
Key terms
- Earnings per share (EPS)
- Net income available to common shareholders divided by the number of common shares.
- Preferred dividends
- Dividends owed to preferred shareholders, who have first claim on profits before common holders.
- Basic EPS
- EPS using only the shares currently outstanding.
- Diluted EPS
- EPS that also counts shares that could be created from options and convertibles. Always less than or equal to basic.
Calculating EPS
A company earns 5,000,000 dollars of net income. It owes 500,000 dollars in preferred dividends and has 3,000,000 common shares outstanding. What is its basic EPS?
- Find earnings for common holders. Subtract preferred dividends: 5,000,000 minus 500,000 is 4,500,000.
- Divide by common shares. 4,500,000 divided by 3,000,000 shares.
- Solve. That equals 1.50 dollars per share.
Why it matters: EPS is the profit that belongs to each common share. Always remove preferred dividends first, since that profit is not the common shareholders'.
Calculate EPS
A company has net income of 8,000,000 dollars, no preferred dividends, and 4,000,000 common shares outstanding. What is its basic EPS?
Basic versus diluted
- Basic EPS uses only the shares currently outstanding.
- Diluted EPS also counts shares that could come into existence from stock options, warrants, and convertible securities, showing the worst-case dilution.
- Diluted EPS is always less than or equal to basic EPS, and it is the more conservative figure that analysts usually emphasize.
Net income is the company's profit. EPS is your share of it, and dilution decides how thinly that profit gets spread.
The buyback subtlety
Here is a point that trips up a lot of beginners. Because EPS divides profit by share count, a company can raise its EPS without earning a single extra dollar, simply by buying back its own shares, which shrinks the denominator. This is not necessarily bad, since returning cash through buybacks can be sensible. But it means rising EPS does not always mean a more profitable business. Always check whether EPS grew because earnings rose or merely because the share count fell.
How to calculate EPS (Edspira)
A worked numeric example that reinforces the calculation. Watch it if the preferred-dividend step still feels unclear.
Real growth or just fewer shares?
A company's EPS rose from 2.00 to 2.20 this year, but its total net income was flat. What most likely happened?
Flat profit but higher EPS points to a smaller share count, typically from buybacks. Rising EPS does not always mean rising profit.Why diluted EPS is the honest one
Explain in a couple of sentences why analysts often pay more attention to diluted EPS than to basic EPS. What is diluted EPS protecting them from?
Write an answer before comparing it with the model response.
Model answer
Diluted EPS counts the extra shares that could be created if stock options, warrants, and convertibles were exercised, which would spread the same profit across more shares. It protects analysts from an overly rosy picture, because it shows the worst-case earnings per share if all those potential shares appeared. Basic EPS can look better simply because it ignores that future dilution.
EPS is the profit attached to each share. In the next lesson we put a price on that profit, using the most famous valuation ratio of all, the price-to-earnings ratio, which has EPS sitting right in its denominator.