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Basic EPS is net income divided by the weighted average number of common shares outstanding. It shows how much profit is attributable to each share.
Basic earnings per share (EPS) measures the portion of net income attributable to each outstanding share of common stock, calculated without considering potential dilution from stock options, convertible securities, or other dilutive instruments. This fundamental metric allows investors to assess profitability on a per-share basis and forms the foundation for the price-to-earnings (P/E) valuation ratio.
The calculation:
Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding
For example, if net income is $200 million, preferred dividends are $10 million, and weighted average shares are 100 million, basic EPS is $1.90.
Why basic EPS matters:
- Per-share profitability: Shows earnings attributable to each share you own
- P/E calculation: Stock Price / EPS = Price-to-Earnings ratio
- Growth tracking: EPS growth drives long-term stock appreciation
- Dividend capacity: EPS relative to dividend shows payout sustainability
Weighted average shares explained:
- Time-weighted: Shares outstanding weighted by portion of period outstanding
- Stock splits: Historical EPS adjusted for splits to enable comparison
- Share issuance/repurchase: Changes during period are prorated
Basic vs. Diluted EPS:
- Basic EPS: Uses actual shares outstanding; higher number
- Diluted EPS: Assumes all convertible securities convert; lower number
- The gap: Larger gaps indicate more potential dilution
Analysing EPS:
- Growth rate: Year-over-year and multi-year compound growth
- Quality: Is EPS growing from operations or financial engineering?
- Buyback impact: Share repurchases boost EPS without profit growth
- Consistency: Volatile EPS makes valuation difficult
EPS growth sources:
- Revenue growth: Most sustainable source
- Margin expansion: Improving profitability on same revenue
- Share reduction: Buybacks reduce denominator
- Tax rate changes: Lower taxes boost EPS unsustainably
Most financial analysis and valuation uses diluted EPS as it's more conservative. However, basic EPS remains important for understanding current profitability and comparing to diluted EPS to assess dilution risk.