What are basic earnings per share?

Basic earnings per share represent a measure of the success of the company. It shows the portion of generated earnings assigned to each common stock. Basic earnings per share (basic EPS) provide an overview regarding the dispersion of income after taxes to the common shares. This measure also shows the company's capacity to generate earnings from its operations. 

They are stated with the income statement. Basic EPS are especially useful when the company's capital structure is composed solely of common stocks.

The value of EPS is used in the calculation of price to earnings ratio (P/E). This ratio is important for investors as it provides an insight into the time needed for a company to cover the funds invested in the company by the investors.

Basic earnings per share explained

Basic EPS calculation is based on the net income generated by the company, the number of common stocks, and any dividend payable to preferred stocks.

Basic EPS = (net income – preferred dividends) / weighted average number of outstanding shares during the period considered

The dividend paid to preferred stocks is subtracted because the basic EPS shows the amount of income generated for the outstanding common shares. The ratio is commonly calculated on an annual basis. The weighted average number of shares is needed because companies can issue new shares during the calculation period.

The value of basic EPS is examined as the value of any other income. Higher basic earnings per share are better for the company and the shareholders.

For instance, company A has generated a net income of $70,000, with a simple capital structure consisting of 10,000 outstanding shares in the same period. Basic EPS for company A are:

Basic EPS = ($70,000 – $0) / 10,000 = $7

The value of $7 indicates that if company A decides to pay out the income earned then shareholders will receive $7 for each share they own. Regardless of its importance, basic EPS may be manipulated, so investors can sometimes exclude this ratio from their analysis.

Basic earnings per share vs diluted earnings per share

Basic earnings per share are an especially useful measure for companies with a certain number of outstanding shares. Nevertheless, a company may decide to issue additional shares in the market. For a company to reflect its real earnings per share after the new round of issuing stocks, diluted earnings per share measure is used. Commonly, the diluted earnings per share value are lower than the basic EPS because the company's income is distributed to a larger number of shares.