Earnings per share (EPS) is a company's net income divided by the weighted average number of common shares outstanding. It is the most widely reported measure of company profitability on a per-share basis.
Basic EPS formula: > Basic EPS = (Net Income − Preferred Dividends) ÷ Weighted Average Common Shares Outstanding
Diluted EPS: Includes the effect of all potentially dilutive securities (stock options, convertible bonds, warrants) that could increase share count. Diluted EPS is always ≤ Basic EPS. > Diluted EPS = (Net Income − Preferred Dividends) ÷ (Shares + Dilutive Securities)
Why preferred dividends are subtracted: Preferred stockholders must be paid before common stockholders; EPS reflects earnings available to common shareholders.
Example: - Net income: $10 million - Preferred dividends: $1 million - Weighted avg shares: 9 million - Basic EPS = ($10M − $1M) ÷ 9M = $1.00 per share
EPS quality: - Earnings quality refers to how sustainable and accurate the reported earnings are. - Watch for non-recurring items, aggressive revenue recognition, or heavy use of non-GAAP adjustments.
EPS and dividends: - Payout ratio = Dividends per share ÷ EPS (% of earnings paid out). - Retention ratio = 1 − payout ratio (earnings retained to fund growth).
Stock buybacks reduce share count → increase EPS even if net income is flat. This can make EPS growth look better than business fundamentals.
> Exam tip: EPS is the denominator of P/E. Diluted EPS is always lower than or equal to basic EPS. A company can boost EPS by buying back shares — know this nuance for the Series 7 and CFP® exams.