What are Basic Earnings Per Share?
Basic earnings per share is a profitability metric that calculates the company’s net income for each common stock. It is useful when the company has a simple capital structure (no dilutive securities like stock options, convertible bonds, etc.)
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- Basic earnings per share (EPS) is a key profitability measure that indicates a company’s net income per common stock.
- It is suitable when a company has a simple capital structure without dilutive securities like stock options or convertible bonds. Basic EPS can also be used as a valuation method.
- When analyzing a company’s EPS, it’s important to consider net profit and outstanding equity shares separately.
- Basic EPS represents earnings available to common shareholders, so it deducts the current year’s preferred dividends from net income.
Basic EPS Formula
Basic EPS Formula = (Net Income – Preferred Dividends) / Weighted Average Common Shares Outstanding
Since basic EPS relates to earnings available only to common shareholders, the current year’s preferred dividends reduce from net income. However, dividends on common shares do not deduct from net income.
Calculate Basic EPS
The above chart shows that Starbucks ‘ basic EPS has increased substantially over the past 5 years. What does this mean? How is this useful for investors? First, let us look at the calculation of the 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 2016 = $2,817.7 million
- Weighted average common shares in 2016 = $1,471.6 million
- Basic EPS = $2,817.7/1,471.6 = $1.91
source – Starbucks 10K filings
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Basic EPS Explanation in Video
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 investing in the company. And it gives them a clear idea about what to expect from the company in the future. However, only looking at basic EPS would not offer them the right insights. They should also look at all the financial statements and find the ratios from the data points they could gather.
- It is pretty easy to prepare. But, first, you need to grab an income statement of the company and the balance sheet. Then, take the net income from the income statement, deduct the preferred dividend Preferred 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 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.
- One may also use it 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.. For example, it helps figure out the price-earnings ratio of a comparable company.
- Since it is the indicator of how much net profit earns if a company has a 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., its net profit is also higher.
How to Interpret Basic EPS?
When comparing the EPS of two companies, you need to look at an important aspect.
- Suppose you are looking at A Co. and B Co. You found that both companies’ EPS is $5 per share.
- It will not be the right interpretation if you conclude that these companies perform similarly.
- If A Co. has 10,000 outstanding shares, the net profit (no preferred dividend) is $50,000.
- And let us also say that B Co. has 2,000 outstanding shares, and the net profit (no preferred dividend paid) is $10,000.
- These cases will portray the same basic EPS, but are they similar in net profits? No. A Co. makes more profit than B Co. Since B Co. 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 it has been doing quite well.
While looking at a company and its EPS, you should look separately at the net profit and the outstanding equity shares.
Basic EPS is a great measure of profitability. There is no doubt about it. But you should know that EPS alone cannot 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 is generating higher yields, and whether one company is doing better than another in terms of earnings per share.
Since the company has prepared the income statement and the balance sheet, it may have manipulated the data to showcase a good reputation to its potential investors.
That is why you should look at the P/E ratio P/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) and basic EPS. However, it would help if you also looked 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 statements like cash flow and fund flow statements.
Frequently Asked Questions (FAQs)
EPS stands for Earnings Per Share, a financial metric representing the portion of a company’s profit allocated to each outstanding share of common stock. Basic EPS considers only the number of common shares outstanding, while diluted EPS takes into account the potential dilution from convertible securities, such as stock options or convertible bonds.
The determination of a “good” basic EPS number depends on various factors, including the industry, company size, growth prospects, and investor expectations. A higher basic EPS generally indicates greater profitability per share, but it’s essential to consider the context and compare it with industry peers or historical performance for a meaningful assessment.
Whether basic or diluted EPS is better depends on the purpose of the evaluation. Basic EPS provides a conservative measure by assuming no potential dilution from convertible securities. On the other hand, diluted EPS accounts for the potential dilution of outstanding shares. If significant dilutive securities are in circulation, diluted EPS may give a more accurate representation of the company’s earnings potential.
This article is a guide to Basic EPS. Here, we discuss the formula for calculating basic earnings per share, practical examples, and its usefulness to investors. You may also have a look at these articles below to enhance your understanding of: –
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