Information > Financial Terms > This page

Earnings per share 
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)      

For basic measures of company profitability, dollar net income after income taxes can be expressed relatively as percentage on sales, i.e., net profit margin, or as percentage on equity, i.e., ROI or return on investment.

But for more specific valuation per unit of investment (i.e., per share of common stock), net income after income taxes and after dividends on the preferred stock, if any, must be reduced by division by outstanding shares of the company into earnings per share, the basic data used in publicity on company earnings, in computing earnings growth over a past period, in projecting potential future growth, and appraising relative market valuation by computing the price-earnings ratio (market times earnings, or earnings as a percentage of market price).

Undue emphasis, however, should not be attached to a single net income figure and to earnings per share for a particular year (American Institute of Certified Public Accountants, Accounting Research Bulletin No. 43, 1953).  Analysis should include the income statement as a whole, including the sources of income and structure of costs, their comparative past record, and the position and outlook for the corporation and its industry.

Computational problems in presenting earnings per share include the following (see APB Opinion No. 15, May, 1969).

1.  Primary earnings per share, simple capital structures (only common stock or
     including no potentially dilative convertible securities, options, warrants, etc.,
     that could in the aggregate dilute over 3% earnings per common share).

a.  Weighted average number of common shares outstanding during
     each period presented should be used, excluding reacquired
     shares from date of acquisition.

b.  Stock dividends, stock splits, or reverse splits (increasing or
     decreasing number of common shares) should be retroactively
     reflected for all past periods presented so as to be comparable with
     present capitalization.

c.  Acquisitions of firms accounted for as purchases and involving
      issuance of shares should reflect the additional shares only from the
     acquisition date.  Combinations of firms accounted for as poolings
     of interests should reflect the aggregate of the weighted average
     outstanding shares of the constituent firms, adjusted to equivalent
     shares of the surviving firm, for all periods presented.

d.  In computing earnings per share, claims of senior securities on
     earnings for a period should be deducted from net income and from
     income before extraordinary (nonrecurring) items if shown in the
     income statement.

2.  Primary earnings per share, including common stock equivalents if capital
     structure is complex and there is dilative effect.

a.  A common stock equivalent is a security which is not in form a
     common stock, but which usually contains provisions to enable its
     holder to become a common stockholder and which, because of its
     terms and the circumstances under which it was issued, is in
     substance equivalent to a common stock.  The APB concluded that
     a common stock equivalent is determined only at the time of
     issuance and should not be changed as long as the security
     remains outstanding.

3.  Fully diluted earnings per share, to show the maximum potential dilution of
     current earnings per share on a prospective basis.

a.  This concept includes senior stock or debt which is convertible into
     common shares but is not a common stock equivalent; options or
     warrants; or agreements for the issuance of common shares upon
     the satisfaction of certain conditions, such as the attainment of
     specified higher levels of earnings following a business
     combination.

b.  The computation should be based on the assumption that all such
     issued and issuable shares were outstanding from the beginning of
     the period or from the time the contingency arose, if after the
     beginning of the period.

c.  Previously reported fully diluted earnings per share amounts should
     not be retroactively adjusted for subsequent amounts conversions or
     subsequent changes in the market prices of the common stock.

d.  The rule is "one-way," i.e., fully diluted earnings per share should
     exclude those securities whose conversion, exercise, or other
     contingent issuance would have the effect of increasing the earnings
     per share amount.

Earnings per share data are widely used in judging the operating performance of a business.  This ratio frequently appears in financial statements and business publications.  It is considered the most significant figure appearing on the income statement because it condenses into a single figure the data reflecting the current net income of the period in relation to the number of shares of stock income from continuing operations and net income.  Earnings per share may be reported for the results from discontinued operations, extraordinary items, or cumulative effects of changes in accounting principles if they are reported on the income statement.  Current accounting practice requires that earnings per share be disclosed prominently on the face of the income statement.

BIBLIOGRAPHY

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, ACCOUNTING PRINCIPLES BOARD, Opinion No. 9, Reporting the Results of Operations, December, 1966.

Opinion No. 15, Earnings per Share, May, 1969.

Back to Information