Basic EPS Uses the Weighted Average Shares Outstanding
Summary
The document explains why basic earnings per share uses a weighted average of shares outstanding during the fiscal year, rather than only the number at the start or end. Shares issued partway through the year count in proportion to the time they were outstanding. In the example, the new shares are issued halfway through the year, so they contribute half their count to the annual weighted average. Dividing net income by that weighted denominator gives the reported basic EPS.
The explanation also gives the rationale for time weighting: it better reflects the capital available to generate the period’s earnings. Using only year-end shares could distort comparisons when a company issues shares or buys them back late in the year. The discussion concerns basic EPS and a simplified share issuance example; it does not cover other adjustments that can apply to EPS under accounting rules.
Key ideas
- Basic EPS divides net income by the weighted average number of common shares outstanding.
- Shares issued during a reporting period are weighted by the portion of the period they were outstanding.
- Using weighted average shares better reflects the capital available to generate earnings during the period.
- Year-end share counts can misrepresent EPS when share issuance or repurchases occur during the year.
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Full text
# Question on earning per share
# Question on earning per share
For 2009, Flamingo Products had net income \$ 1,000,000. At 1 January 2009 there were 1,000,000 outstanding. On 1 July 2009,the company issued 100,000 new shares for \$ 20 per share. The company paid \$200,000 in dividend to common stockholders. What is Flamingo's basic EPS for 2009?
Basic EPS $=\frac{Net \ Income}{No. \ of \ outstanding \ shares} = \frac{1000000}{1000000}=1$
But the answer is 0.95 with outstanding No. of shares of 1050000.
I can't suss out where this additional 50000 in outstanding shares come from.
## Answer by Vincent C. (score 4, accepted)
https://quant.stackexchange.com/a/45396
Great question, this detail is often overlooked but keep in mind that the correct formula is:
EPS = Net Income/Weighted average no. of shares
So we have to consider the weight of each new issue of shares. The the additional issue period of (July 1 to Dec 31) has a weight of 6/12. I created a table in the link below to help visualize the problem. Hope it helps! :)
## Answer by alexbougias (score 2)
https://quant.stackexchange.com/a/45414
Vincent's answers summarizes everything. Although, why should accounting standards pose such a restriction on EPS calculation?
New shares issued are weighted with the period outstanding till the end of the fiscal year. This modification is used, instead of the outstanding shares at the last day of the year, to reflect the real capital used to generate firm's revenues. Basic weighted average shares limit the possibility of firm reporting "biased" EPS. If firm engages in a share buyback program, then EPS can be inflated providing illusional profitability to investors. On the other hand, if firm issues new capital, at the end of the period, reported EPS would shrink. The latter is not the common case, since lower EPS are not alligned with shareholder's and Manager's interests. It can still, however, provide a way to misinform investors.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.