Earnings Per Share

Basic Earnings per share =

Net Income (loss) for the period – preferred dividends
Weighted average number of common shares of stock outstanding

Weighted Average:
Consider the length of time shares are outstanding

1) Acquiring treasury stock is treated like a retirement of shares

2) Reissuing treasury stock is treated like an issuance of new shares

3) Stock dividends, stock splits and reverse splits require retroactive adjustment of all share amounts. (Assume the split or dividend occurred on the first day of the period).

4) Exercise of stock options and conversions increase common shares outstanding.

Example: On January 1st, the company’s capital structure consisted of 50,000 shares of $10 par common stock and 1,000 shares of 9%, $100 par cumulative preferred. On April 1st, the company issued 3,000 additional common shares. On July 1st, the company paid a three for one stock split. On September 1st, 4,500 shares were purchased as treasury stock and on October 1st, 3,000 shares of treasury stock were reissued. Net income for the year ended December 31, was $294,000. No dividends were declared during the year.

Weighted Average Calculation:

Preferred dividends is computed as # shares issued x par value x stated %

Cumulative: the dividend is always subtracted even if it is not declared this
year because it could be paid in the future.

The only time preferred dividends is not subtracted is when the dividend is not declared and the preferred stock is non cumulative.

Notice that the 3:1 stock split is also applied to each time period prior to the split

Multiply by the number of months the company had the number of shares outstanding / 12 (or days shares were outstanding / 360)

EPS is per Common Share,
Do not include preferred shares in the computation

Diluted:

What EPS would be if all potential shares from current convertible financial instruments were converted

This is a “pretend”, “what if”, earnings per common share

Begin with the BASIC EPS computation and make changes to the computation
to add additional shares that would be issued and preferred dividends and interest that would not be paid assuming conversion of common stock equivalents occurs.

Common Stock Equivalents:
Financial instruments that have the potential to increase the number of common shares outstanding

Convertible Bonds:
The “If Converted” method is used

Assume conversion to common stock which will increase outstanding common shares. Add the increase to weighted average shares.

Assume interest is not paid because you don’t have the convertible bond;
add the interest not paid back to net income (net of tax)

Assume the conversion occurs at the beginning of the year as long as it was issued and outstanding on January 1st.

If not, only include the months the security was actually issued and outstanding.

Convertible Preferred Stock:
The “If Converted” method is used

Assume conversion to stock which will increase outstanding common shares.
Add the issued shares to number of weighted average shares.

Assume no dividend is paid because you no longer have the preferred stock;
the dividend is not deducted from income

Assume the conversion occurs at the beginning of the year as long as it was
issued and outstanding on January 1st.

If not, only include the months the security was actually issued and outstanding.

Stock Options and Warrants:
Use the “Treasury Stock” method is used

Assume the option/warrant is exercised: the company issues new common shares and receives cash of the exercise price per share.

Assume the company uses the cash received to repurchase shares at the average fair market value for the period.

The net of the issued shares and the repurchased shares is added to weighted average number of shares

Anti-dilutive:
Occurs when Diluted EPS > Basic EPS

Anti-dilutive is NOT ALLOWED by GAAP

Do not include a conversion in the calculation of diluted EPS if it causes Diluted EPS to be higher than Basic EPS.

Determine which convertible security is causing the anti-dilutive and remove that assumed conversion from the EPS calculation.