Basic Earnings Per Share (EPS)

What is Basic EPS?

Basic earnings per share (EPS) measures how much of a company’s net income is attributable to each share of common stock. It is reported on the income statement and is most informative for companies with simple capital structures (only common stock outstanding).

Basic EPS does not account for the potential dilution from convertible securities (stock options, convertible preferred stock, warrants). When a company has a complex capital structure, it must also report diluted EPS, which assumes all dilutive securities are exercised.

Formula

Basic EPS = (Net income − Preferred dividends) ÷ Weighted average common shares outstanding

• Net income used can be either income from continuing operations or total net income, depending on the context.
• Preferred dividends are subtracted because that portion of income is not available to common shareholders.
• The denominator uses the weighted average number of common shares outstanding during the reporting period.

Weighted Average Shares — Short Explanation

If the number of shares changes during the period (e.g., issues or buybacks), the weighted average accounts for the time each share count was outstanding. Example weighting for two halves of a year:
Weighted average = (Shares in first half × 0.5) + (Shares in second half × 0.5)

Example

• Net income: $100 million
• Preferred dividends: $23 million → Earnings available to common = $77 million
• Shares outstanding: 100 million at start; 20 million new shares issued mid-year → shares were 100 million for first half and 120 million for second half
• Weighted average shares = (100 × 0.5) + (120 × 0.5) = 110 million
• Basic EPS = $77 million ÷ 110 million = $0.70

Impact and Limitations

• Stock prices often trade on earnings multiples, so rising basic EPS can support higher share prices.
• Basic EPS can increase even if absolute net income falls, if the company repurchases shares and reduces the share count.
• Basic EPS ignores potential dilution. The larger the gap between basic and diluted EPS, the greater the potential dilution to current shareholders if convertible securities are exercised.
• For companies with complex capital structures, diluted EPS provides a more conservative view of per-share earnings.

Key Takeaways

• Basic EPS shows net income per common share after preferred dividends.
• It is appropriate for companies with simple capital structures; companies with possible dilution must also report diluted EPS.
• Basic EPS will always be equal to or higher than diluted EPS.
• Watch for share count changes and the difference between basic and diluted EPS to assess the sustainability of EPS trends.