What is Basic EPS?
Basic EPS, or Basic Earnings Per Share, is one of the financial metrics that measure a company’s profitability. Specifically, Basic EPS measures the amount of Net Income a company earns for each of its common stock outstanding.
To calculate Basic EPS, we divide Net Income by the Basic Weighted Average Shares Outstanding (Basic WASO). For example, suppose a company has $1 million Net Income and 1 million Basic WASO. In this case, its Basic EPS is $1.00.
A lot of articles online would tell you that Basic EPS is really important. The logic is that it helps investors and analysts evaluate a company’s per share profitability and value. Afterall, it’s difficult and potentially discrediting to argue it’s anything but that. But the truth is that Basic EPS is not important. While EPS is important, Basic EPS is not. Essentially, EPS has two variations: Basic EPS and Diluted EPS. Basic EPS is the rarely-if-ever-used version of EPS. Diluted EPS, on the other hand, is the nearly-always-used version of EPS. We go over this concept in detail in our curriculum: Course 6, Lessons 11-12.
In fact, Basic EPS is a number that barely gets used among finance professionals. We don’t recall ever basing our analyses on this number during our investment banking work at Goldman Sachs.
The reason Basic EPS is almost never used is because it does not take into account potential dilution. Dilution occurs when a company issues additional shares of common stock. Dilution can decrease the Earnings per Share. Therefore, analysts prefer to use Diluted EPS, which factors in the potential impact of dilution on earnings per share.
Basic EPS is typically reported by companies in on the Income Statement.
Basic EPS Formula
Here’s the formula to calculate Basic EPS.
The formula is actually very simple. We simply take the company’s Net Income and divide it by the Basic Weighted Average Shares Outstanding.
Basic EPS Example
Let’s take a look at Apple. For the 2022 fiscal year (page 29), Apple reported $99.8 billion in Net Income and 16.22 billion Basic WASO. To calculate Basic EPS, we can divide the two numbers.
Basic EPS = Net Income / Basic WASO = $99.8 billion / 16.22 billion Basic WASO.
Basic EPS = $6.15 per share.
So, Apple’s Basic EPS for the 2022 fiscal year was $6.15 per share. This means the company earned $6.15 of profit for each of its shares in 2022.
Most companies’ Basic EPS is as simple as this. However, for a minority set of companies, there can be curveballs. In the next section, we’ll go over different curveballs that might arise when calculating Basic EPS.
Impact of Preferred Stocks
The first curveball that can come up when calculating Basic EPS is when the company in question has Preferred Stocks. The vast majority of companies don’t have Preferred Stocks. They only have Common Stocks. However, a small subset of companies has Preferred Stocks. These Preferred Stocks often have fixed dividends.
Recall that Basic EPS measures the amount of Net Income a company earns for each of its common stock outstanding. Conceptually, it measures the common stocks’ entitlement to profit. Therefore, we have to subtract out the portion of Net Income that the company will pay to preferred shareholders.
Thus, for companies with Preferred Stocks, the formula for Basic EPS becomes as follows.
Formula: Basic EPS = (Net Income – Preferred Dividends) / Basic WASO
Impact of Non-Controlling Interest
The second curveball that can come up when calculating Basic EPS is when the company in question has Non-Controlling Interest (see Course 10, Lesson 28). The vast majority of companies don’t have Non-Controlling Interest (NCI), so this doesn’t come up very often. Luckily, handling NCI in Basic EPS is actually pretty simple.
Starting with Net Income including NCI, we subtract Net Income Attributable to NCI. This gives us the Net Income excluding Non-Controlling Interest, which is what’s attributable to the company’s common shareholders. Then, we divide this Net Income Attributable to Common Stocks by Basic WASO to get Basic EPS.
Formula: Basic EPS = (Net Income – Net Income Attributable to NCI) / Basic WASO
Uber, for example, is a company that has Non-Controlling Interest. Here’s Uber’s Income Statement for 2022 fiscal year (page 74). The Net Income number you should use for Basic EPS is the “Net Income (Loss) Attributable to Uber Technologies, Inc.” That’s the profit metric after deducting the profit attributable to Non-Controlling Interest.
Impact of Non-Recurring Items
The Basic EPS that companies report on the Income Statement are usually GAAP numbers. They usually include one-time, non-recurring items. Ideally, you should adjust the reported Basic EPS to neutralize the impact of these non-recurring items. This way, you get a normalized Basic EPS that more accurately reflects the company’s ongoing earnings potential. Adjusting earnings is a pretty big topic on its own so we won’t dig too deep into it here.
Basic vs. Diluted EPS
The difference between Basic EPS and Diluted EPS lies in the number of outstanding shares used to calculate EPS.
Basic EPS divides the company’s Net Income by basic outstanding shares of common stock. This means that the company only takes into account the shares that are currently in existence.
Diluted EPS divides the company’s Net Income by diluted outstanding shares of common stock. This means that the company not only includes the shares that are currently in existence but also shares that will eventually come into existence in the future. In other words, Dilute EPS takes into account the potential impact of dilution on EPS. Dilution occurs when a company issues additional shares of common stock or securities that can be converted into common stock, such as stock options, warrants or units. These additional shares or securities will reduce the shareholders’ true EPS. As a result, most professional analysts use Diluted EPS to measure the company’s profitability on a per share basis. Our curriculum goes over the concept of dilution in detail in Course 3.
To calculate Diluted EPS, the potential dilutive effect of these additional shares or securities is factored in. This is done using the “Treasury Stock Method” or the “If-Converted Method”. The two methods assume that the additional shares or securities are actually exercised or converted into common stock, and the proceeds are used to buy back outstanding shares of common stock.
By factoring in the potential dilutive effect of additional shares or securities, Diluted EPS provides a more conservative estimate of earnings per share than Basic EPS. Diluted EPS is typically lower than Basic EPS.
In summary, Basic EPS assumes that there are no potential dilutive securities outstanding. It only takes into account shares that currently exist. By contrast, Diluted EPS factors in the impact of dilutive securities that can create additional shares in the future. Consequently, Diluted EPS provides a more conservative and truer estimate of earnings per share.
Do You Use Basic or Diluted WASO for EPS?
Companies calculate Basic EPS using Basic WASO. Net Income divided by Basic WASO equals Basic EPS.
Companies calculate Diluted EPS using Diluted WASO. Net Income divided by Diluted WASO equals Diluted EPS.
Should You Use Basic or Diluted EPS?
For valuation analysis, you nearly always use Diluted EPS. You almost never use Basic EPS. We’re using “almost never” instead of a simple “never” to not be absolute. After all, never say never. For example, let’s say you’re trying to calculate a company’s P/E multiple. In this case, you’d use the stock’s current stock price for the numerator and Diluted EPS for the denominator.
How to Increase Basic EPS
From an investor’s perspective, the higher the EPS the better. That’s because a higher EPS means the company is earning more profit for each share. If we own a company’s stocks, we naturally want the company to earn as much profit per share as possible.
So how can companies increase Basic EPS? Well, based on the formula, there’re really two levers that companies can pull. They must either increase Net Income or decrease Basic WASO. To increase Net Income, they must either increase Revenue or decrease Cost. To decrease Basic WASO, they must do share buybacks. That’s how companies can increase Basic EPS.
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