Basic EPS is computed by dividing income available to the common stockholders by the average number of shares outstanding:
EPS = Net income available for common shareholders / Average number of common shares outstanding
For example, Starbright Company reported net income of $99 million in 2001 and had 45 million shares of common stock outstanding throughout the entire year. Starbright’s 2001 EPS is $2.20, calculated as follows:
EPS = $99 million / 45 million shares
EPS = $2.20
Basic EPS Calculations with Changes in Shares Outstanding
It is unusual fora large firm’s outstanding shares to remain constant throughout the year. Additional stock transactions cause the number of shares to vary over the year. In these cases, the denominator in the EPS calculation is the weighted average of the common shares outstanding during the year.
Basic EPS Calculations with Preferred Stock Outstanding
When a firm has both preferred and common stock outstanding, the preferred stock’s share of net income must be subtracted in order to determine the basic EPS of the common stock. This is required because dividends must be paid to preferred shareholders before any earnings are available to common shareholders. Cumulative preferred stock always must be allocated its portion of net income. Noncumulative preferred stock is assigned a portion of income only in years when the firm actually declares a preferred stock dividend.