Earnings Per Share (EPS)
Earnings Per Share (EPS)
The portion of a company's net income, after subtracting preferred dividends, allocated to each outstanding share of common stock, calculated as (Net Income - Preferred Dividends) ÷ Common Shares Outstanding. EPS is the fundamental per-share profitability metric used in valuation ratios like P/E ratio and fundamental analysis. Companies report both basic EPS (using actual shares outstanding) and diluted EPS (including potential shares from options, warrants, and convertible securities).
ABC Corporation reports $10 million in net income for the year with 5 million shares outstanding. Basic EPS = $10M ÷ 5M shares = $2.00 per share. If the company also has convertible bonds that could add 500,000 shares, diluted EPS = $10M ÷ 5.5M shares = $1.82 per share. Investors use the $2.00 EPS to calculate the P/E ratio and assess profitability trends.
Students often confuse basic EPS with diluted EPS. Basic EPS uses only actual outstanding shares, while diluted EPS includes all potential shares from convertible securities, options, and warrants. Additionally, stock splits and stock dividends affect shares outstanding but not net income, so they reduce EPS proportionally without changing company value.
How This Is Tested
- Calculating basic EPS given net income and shares outstanding
- Understanding how stock splits affect EPS (splits increase shares, reducing EPS proportionally)
- Distinguishing between basic EPS and diluted EPS for valuation purposes
- Recognizing EPS as the numerator component in dividend payout ratio calculations
- Using EPS trends to evaluate company profitability growth over time
Regulatory Limits
| Description | Limit | Notes |
|---|---|---|
| Basic EPS formula | (Net Income - Preferred Dividends) ÷ Common Shares Outstanding | Subtracts preferred dividends first; uses actual common shares outstanding, excluding treasury shares |
| Diluted EPS formula | Net Income ÷ (Shares Outstanding + Potential Shares) | Includes potential shares from options, warrants, convertible securities |
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
Thomas, a fundamental analyst, is evaluating two technology companies for a client's growth portfolio. Company X reports EPS of $4.50 with a current stock price of $90, while Company Y reports EPS of $3.00 with a stock price of $75. Both companies have similar growth rates and industry positions. Thomas notices that Company X has substantial employee stock options outstanding that could add 20% more shares if exercised, while Company Y has minimal dilution potential. Which statement best describes the analytical challenge Thomas faces?
B is correct. Thomas should examine diluted EPS to understand the true per-share profitability after accounting for potential share dilution. Company X's basic EPS of $4.50 could drop significantly (potentially to $3.75 if 20% more shares are added: $90 ÷ 1.20 = approximately $3.75 diluted EPS) once employee options are exercised, making direct comparison with Company Y's $3.00 EPS misleading without this context. Diluted EPS provides a more conservative and comparable measure of profitability.
A is incorrect because basic EPS alone doesn't reveal the full picture when significant dilution potential exists. C is incorrect because valuation requires both EPS and price (P/E ratio = Price ÷ EPS), not EPS in isolation. D is incorrect because lower EPS doesn't automatically indicate overvaluation; the P/E ratio (Company Y: $75 ÷ $3.00 = 25x vs Company X: $90 ÷ $4.50 = 20x) suggests Company Y trades at a higher multiple, but this requires context about growth rates and dilution.
The Series 65 exam tests your ability to use EPS appropriately in fundamental analysis, particularly understanding when diluted EPS provides more accurate valuation insights than basic EPS. This is critical for making suitable investment recommendations based on company fundamentals.
How is basic Earnings Per Share (EPS) calculated for a corporation?
B is correct. Basic EPS is calculated as Net Income ÷ Shares Outstanding. This measures the company's net profitability (after all expenses, interest, and taxes) allocated to each share of common stock. It is the most fundamental per-share profitability metric used in equity analysis and valuation.
A is incorrect because revenue (top-line sales) is not profitability; EPS uses net income (bottom-line profit) after all expenses. C describes diluted EPS (which includes potential shares), and uses operating income instead of net income. D describes dividend per share, not earnings per share; companies can retain earnings rather than paying them all as dividends.
The Series 65 exam frequently tests knowledge of fundamental financial metrics and their calculations. Understanding that EPS uses net income (not revenue or operating income) and actual shares outstanding (for basic EPS) is essential for evaluating equity securities and making appropriate recommendations.
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Access Free BetaDEF Corporation reports net income of $15.6 million for the fiscal year. The company has 3 million shares of common stock outstanding and paid $3.6 million in total dividends to common shareholders during the year. What is the company's basic earnings per share (EPS)?
C is correct. Calculate basic EPS using the formula: EPS = Net Income ÷ Shares Outstanding.
EPS = $15.6 million ÷ 3 million shares
EPS = $5.20 per share
Note that dividends paid ($3.6 million) are NOT subtracted from net income when calculating EPS. Net income already represents the company's earnings after all expenses. The dividends represent how much of those earnings were distributed to shareholders, but EPS measures total earnings per share regardless of distribution policy.
A ($1.20) incorrectly uses only the dividends: $3.6M ÷ 3M shares. B ($4.00) incorrectly subtracts dividends from net income: ($15.6M - $3.6M) ÷ 3M shares = $12M ÷ 3M. D ($6.40) results from calculation errors or incorrectly adding dividends to net income.
EPS calculation questions are common on the Series 65 exam because they test your understanding of fundamental financial analysis. Recognizing that dividends don't affect EPS calculation (they affect dividend payout ratio instead) is critical for accurate equity analysis and valuation.
All of the following statements about Earnings Per Share (EPS) are accurate EXCEPT
C is correct (the EXCEPT answer). A 2-for-1 stock split does NOT double EPS; it actually HALVES EPS because it doubles the shares outstanding while net income remains unchanged. For example, if a company had $10M net income and 5M shares (EPS = $2.00), after a 2-for-1 split it would have the same $10M net income but 10M shares (EPS = $1.00). Stock splits don't change company value or total earnings, only the number of shares.
A is accurate: the basic EPS formula is Net Income ÷ Shares Outstanding. B is accurate: diluted EPS includes potential shares from convertible securities, options, and warrants to show worst-case dilution. D is accurate: P/E ratio = Price ÷ EPS, so EPS is the denominator in this key valuation metric.
The Series 65 exam tests your understanding of how corporate actions like stock splits affect per-share metrics. Understanding that stock splits proportionally reduce EPS (while maintaining total company value) prevents incorrect analysis of profitability trends when companies split their stock.
GHI Corporation reports the following for the current fiscal year: Net income of $20 million, 4 million common shares outstanding, employee stock options that could add 400,000 shares if exercised, and convertible bonds that could add 600,000 shares if converted. The company paid $6 million in common stock dividends. Which of the following statements are accurate?
1. Basic EPS is $5.00 per share
2. Diluted EPS is $4.00 per share
3. The dividend payout ratio is 30%
4. A 2-for-1 stock split would increase EPS to $10.00 per share
D is correct. Statements 1, 2, and 3 are accurate.
Statement 1 is TRUE: Basic EPS = Net Income ÷ Shares Outstanding = $20M ÷ 4M shares = $5.00 per share.
Statement 2 is TRUE: Diluted EPS = Net Income ÷ (Shares Outstanding + Potential Shares). Potential shares = 400,000 (options) + 600,000 (convertible bonds) = 1,000,000 total potential shares. Diluted EPS = $20M ÷ (4M + 1M) = $20M ÷ 5M shares = $4.00 per share.
Statement 3 is TRUE: Dividend Payout Ratio = Dividends ÷ Net Income = $6M ÷ $20M = 0.30 = 30%.
Statement 4 is FALSE: A 2-for-1 stock split would HALVE EPS, not increase it to $10.00. After the split, shares would double to 8M (4M × 2), so EPS = $20M ÷ 8M = $2.50 per share. Stock splits don't change net income, only the number of shares, so EPS decreases proportionally.
The Series 65 exam tests multi-dimensional understanding of EPS calculations, including basic vs diluted EPS, how EPS relates to dividend payout ratios, and how corporate actions like stock splits affect per-share metrics. This comprehensive knowledge is essential for fundamental analysis and equity valuation.
💡 Memory Aid
Think of EPS as "Earnings Per Slice" of the company pie: Net income is the whole pie, shares are the slices. More slices (stock split) = smaller earnings per slice. Diluted EPS = count potential future slices too (options, convertibles). Remember: Stock splits SPLIT the earnings, making EPS smaller, not bigger!
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