Title: Earnings per Share
1Earnings per Share
- The Introductory Lecturefor Acct 592
2The most closely watched statistic on Wall Street
- Earnings per share (EPS) is an important
indicator of the success or failure of a company.
3Several components of EPS must be disclosed if
there are discontinued operations, extraordinary
items, or cumulative effects of changes in
accounting principles.
- Earnings Per Share
- Continuing operations
3.15 - Discontinued operations
.67 - Extraordinary loss
(.15) - Cumulative effect of accounting change .17
- Net Earnings Per Share
3.84
Cumulative effect item pretty much gone after
SFAS No. 154
4There may be two EPS numbers for each item
Diluted
Basic
Reflects the maximum potential dilution from all
possible stock conversions that would have
decreased EPS.
Considers only common shares outstanding
5Diluted earnings per share
- I like to think of it as the worst case
scenario - It is the lowest possible number wed report for
EPS - It is a proforma number, not a fact
6Capital structure determines reporting
- Many companies will report basic earnings per
share only - Other companies must report BOTH basic and
diluted earnings per share - It depends on whether the capital structure is
- Simple, or
- Complex
7A simple capital structure consists of only
common stock.
The corporation has only common and
nonconvertible preferred stock and has no
convertible securities, stock options, warrants,
or other rights outstanding.
8Capital Structures
Complex Capital Structure The corporation has
one or more instruments outstanding that could
result in issuance of additional common shares.
9Capital Structures
Therefore, a company with potential per share
dilution is considered to have a complex capital
structure.
Note that a potentially dilutive security does
not necessarily dilute EPS
10Dilution of Earnings
- Dilutive Securities Securities whose assumed
exercise or conversion results in a reduction in
earnings per share. - Antidilutive Securities Securities whose
assumed conversion or exercise results in an
increase in earnings per share.
11Basic Earnings Per Share
Net Income - Preferred Dividends Weighted
average number of common shares outstanding
12Earnings Per Share Example
- A company has the following capital structure at
the end of 2002 - 6 Cumulative preferred stock, 100 par value,
issued and outstanding 10,000 shares - Common stock, 10 par, issued 200,000 shares,
outstanding 180,000 shares - Treasury stock (20,000 shares at cost of 18)
13EPS Example
- During 2003, the following transactions take
place - April 1, 2003 issued 100,000 shares to acquire
the assets of another company. Market value of
shares was 25 - June 30, 2003 declared and distributed a 2 for
1 stock split effected in the form of a stock
dividend - September 1, 2003 sold 10,000 shares of the
treasury stock for 28 per share
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14Step 1 find weighted average shares outstanding
15Step 1 find weighted average shares outstanding
16EPS Example
- During 2003, the following transactions take
place - April 1, 2003 issued 100,000 shares to acquire
the assets of another company. Market value of
shares was 25 - June 30, 2003 declared and distributed a 2 for
1 stock split effected in the form of a stock
dividend - September 1, 2003 sold 10,000 shares of the
treasury stock for 28 per share
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17Stock Splits Dividends
- All stock splits and stock dividends must be
incorporated into the computation of weighted
average shares outstanding.
- This must done for all periods presented in the
financial statements.
18Step 1 find weighted average shares outstanding
19Stock Splits Dividends
- This years EPS figures may have to be changed in
the future as a result of stock splits or
dividends. - Think about what would happen if we did NOT make
the adjustment . . .
20EPS Example
- During 2003, the following transactions take
place - April 1, 2003 issued 100,000 shares to acquire
the assets of another company. Market value of
shares was 25 - June 30, 2003 declared and distributed a 2 for
1 stock split effected in the form of a stock
dividend - September 1, 2003 sold 10,000 shares of the
treasury stock for 28 per share
Page 109
21Step 1 find weighted average shares outstanding
22Step 1 find weighted average shares outstanding
Multiply shares outstanding by fraction of year
and by split factor
Add em up
Make sure you have accounted for all 12 months
and no more than 12 months!
23Step 2 - numerator
- Net income 3,000,000
- Preferred dividends 10,000 shares 100
6 60,000
Note Always include preferred dividend if it is
cumulative preferred stock. If not cumulative,
only include preferred dividend if declared
during year
Now lets plug everything into the formula . . .
24Step 3 compute basic EPS
25What if . . .
- Taking the same facts, what if the preferred
stock was convertible into 10 shares of common
stock at the option of the stockholder? - This would make it a complex capital structure
and wed have to report both the basic EPS we
computed plus a diluted earnings per share
figure.
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26Convertible preferred
- The 10,000 shares of preferred could become
100,000 shares of common stock (outstanding all
year) - We would NOT pay the preferred dividend because
there would be no preferred stock
27Diluted EPS
- Diluted EPS 4.89
- Both the 5.73 and the 4.89 would be reported on
the face of the income statement
28Formula for diluted EPS
Net income - Preferred dividends if preferred stock is NOT convertible After-tax bond interest on conver-tible bonds
Weighted average of common shares assuming maximum dilution (including options) Weighted average of common shares assuming maximum dilution (including options) Weighted average of common shares assuming maximum dilution (including options)
29Diluted Earnings per Share
- For convertible bonds and convertible preferred
stock we use what is called the If Converted
Method - For options, we use the Treasury Stock Method
30Treasury Stock Method
- Proceeds from conversion are assumed to be used
for purchase of treasury stock at current market
price. - Treasury stock is assumed to be reissued to
option or warrant holders. - Any additional shares issued, over treasury
stock, are added to weighted- average shares
outstanding. - Exercise is assumed to occur on the first day of
the year unless issue date is later.
31Treasury Stock Method--Example Basic Data
- Assume the following
- Net Income 8,000
- Common Shares Outstanding (entire year)
6,000 - 1-for-1 Options Outstanding 2,000
- Exercise Price Per Share on Options 30
- Average Price of Common Shares 40
- Income Tax Rate 40
32Treasury Stock Method--Example
33Treasury Stock Method--Example Option Proceeds
- Options Assumed Exercised (2,00030) 60,000
cash received - Shares Assumed Repurchased With Proceeds
(60,000 / 40) 1,500 - Additional Shares Assumed Issued2,000 from
exercise less 1,500 purchased with proceeds 500
net new shares
34Treasury Stock Method--Example
8,000/6,500
35Getting the lowest possible number an algorithm
- 1. Compute the per share effect of each
potentially dilutive security separately. - 2. Make a list from smallest per share number to
largest per share number - 3. Compute basic earnings per share
- 4. For diluted EPS, take the securities into EPS
computation one at a time until the next item on
the list is bigger than the most recent EPS
figure.