What is Basic Earnings Per Share?
Basic Earnings Per Share is a profitability metric that calculates the net income of the company for each common stock. Basic EPS is useful when the company has a simple capital structure (no dilutive securities like stock options, convertible bonds etc)
Basic EPS Formula
Basic EPS Formula = (Net Income – Preferred Dividends) / Weighted Average Common Shares Outstanding
Because Basic EPS relates to earnings available only to common shareholders, the current year’s preferred dividends are reduced from net income. Dividends on common shares are not deducted from net income.
Calculate Basic EPS
We note from the above chart that Starbucks Basic EPS has increased substantially over the past 5 years. What does this mean, and how does is this useful for investors? Let us look at the calculation of basic EPS of Starbucks and its interpretation
- Net Earnings of Starbucks in 2017 = $2,884.7 million
- Weighted average common sharesWeighted Average Common SharesWeighted Average Shares Outstanding is a calculation used to estimate the variations in a Company’s outstanding shares during a given period. It is determined by multiplying the outstanding number of shares (consider issuance & buybacks) in a given reporting period with their individual time-weighted portions. 2017 = 1,449.5 million
- Basic EPS = $2,884.7/1,449.5 = $1.99
- Net Earnings of Starbucks in 2017 = $2,817.7 million
- Weighted average common shares 2017 = 1,471.6 million
- Basic EPS = $2,817.7/1,471.6 = $1.91
source – Starbucks 10K filings
How Useful is Basic EPS to the Investors?
- EPS is one of the best measures of profitability. As a result, every investor looks at EPS before they ever decide to invest in the company. And it gives them a clear idea about what to expect from the company in the near future. However, only looking at basic EPS won’t offer them the right insights. They also should look at all the financial statements and find out the ratios from the data points they could gather.
- It is pretty easy to prepare. You need to grab an income statement of the company and the balance sheet. Take the net income from the income statement, deduct the preferred dividendPreferred DividendPreferred dividends refer to the amount of dividends payable on preferred stock from profits earned by the company, and preferred stockholders have priority in receiving such dividends over common stockholders. (if any) and then divide the figure by the outstanding equity shares. And you will get a figure to look up.
- If you have been thinking of investing in any one of the companies, you can look at the EPS of each company and then decide which company provides more value per share. You can compare and understand, which makes the decision-making process easier.
- It is also used in the relative valuation methodValuation MethodDiscounted cash flow, comparable company analysis, comparable transaction comps, asset valuation, and sum of parts are the five methods for valuing a company.. It helps figure out the price-earnings ratio of a comparable company.
- Since it is the indicator of how much net profit has been earned, if a company has higher basic earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is., it is considered that the net profit of the company is also higher.
How to Interpret Basic EPS?
When you compare the EPS of two companies, you need to look at an important aspect.
- Let’s say you’re looking at Company A and Company B. You found that the EPS of both of these companies is $5 per share.
- If you conclude that both of these companies are performing similarly, it wouldn’t be the right interpretation.
- Let’s say Company A has 10,000 outstanding shares and the net profit (no preferred dividend given) is $50,000.
- And let’s also say that Company B has 2000 outstanding shares and the net profit (no preferred dividend paid) is $10,000.
- Both of these cases will portray that they have the same basic EPS, but are they similar in net profits? No. Company A makes more profit than Company B. Since Company B has fewer outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet., it seems that it has been doing quite well.
While looking at a company and its EPS, you should look into the net profit and the outstanding equity shares separately.
Basic EPS is a great measure of profitability. There’s no doubt about it. But one thing you should know that EPS alone can’t depict a great deal about a company’s financial health.
Yes, it can talk about how much net profit a company has been earning, whether a company has been generating higher profits, and also whether one company is doing better than another company in terms of earnings per share.
But since the company has been preparing the income statement and the balance sheet, there’s a chance that the company has manipulated the data to showcase a good reputation to its potential investors.
That’s why you should look at P/E RatioP/E RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. (Price/Earnings Ratio) also along with basic EPS. Plus, you should also look at other financial ratios like Return on Total Assets, ROCEROCEReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed., Diluted EPSDiluted EPSDiluted EPS is a financial ratio to check the quality of the Earnings per Share after taking into account the exercise of Convertible Securities like Preference Shares, Stock Option, Warrants, Convertible Debentures etc., and the statement like cash flow statement and fund flow statement.
Basic EPS Video
This is a guide to what is Basic EPS and its meaning. Here we discuss the formula to calculate basic earnings per share along with practical examples and its usefulness to investors. You may also have a look at these articles below to enhance your understanding about Profitability