Earning per Share

1
Chapter

• Earning per Share

2
Earning Per Share

• Earning Per Share often is considered to be the
  single measure that best summarizes the
  performance of a company, particularly for common
  stockholder.

3
Simple Capital Structure

• A capital structure that consists of only common
  stock and non-convertible preferred stock ( no
  potentially dilute convertible securities such as
  stock options, convertible bonds,convertible
  preferred stock).

4
Simple Capital Structure(contd.)

• For a simple capital structure, the basic
  earnings per share (EPS) computation is
• Net Income - Preferred Dividend
• -----------------------------------------------
  ----
• Weighted Average Number of Common
• Shares Outstanding

5
Simple Capital Structure(contd.)

• Example of computing weighted average shares
• Assume a corporation had 12,000 shares of
  common stock (C.S) outstanding at the beginning
  of the year.On 3/2, it issued 2700 shares on7/3,
  it issued another 3,300 shares and on December
  1, it acquired 480 shares as treasury stock. The
  weighted average number of common shares to be
  used in computing EPS is 15,860 shares, as
  computed in Exhibit 1

6
Simple Capital Structure Exhibit 1

• Months shares Shares Fraction of
  Year Equivalent
• Are Outstanding Outstanding Outstanding
  Whole Units
• Jan - Feb 12,000
  2/12 2,000
• March - June 14,700
  4/12 4,900
• July - Nov 18,000
  5/12 7,500
• December 17,520
  1/12 1,460
• Total Weighted Average Common Shares
  15,860

7
Weighted Average Shares and Stock Dividends or
Splits

• Retroactive recognition is given to the events of
  stock dividend or stock split for all components
  of stock dividend or stock split for all
  comparative income statement presented The
  purpose of the retroactive adjustment is to
  result in comparable EPS amounts for all periods
  presented in terms of the most recent capital
  structure.

8
Weighted Average Shares and Stock Dividends
or Splits Example

• A corporation begins operations in January
• 1994, and issues 5,000 shares of common stock
• that are outstanding during all 1994.
• On 12/31/94, it issues a two-for-one stock
  split.
• At the end of 1994, the weighted average
• number of shares to be used in EPS
• computation is 10,000 (5,000200 12/12)
• because the two- for-one split is assumed to
• have occurred on January1, 1994.

9
Weighted Average Shares and Stock Dividends
or Splits Example(contd.)

• On May 29, 1995, the company issues 5,000
• shares of common stock on August 3, 1995,
• it issues a 20 stock dividend and on October
• 5,1995, it issues 2,000 shares of common stock.
• At the end of 1995, when presenting
• comparative EPS for 1994 and 1995, the
• weighted average number of shares to be used
• in the computation are 12,000 shares for 1994
• and 16,000 shares for 1995,
• as shown in exhibit 2.

10
Weighted Average Shares and Stock
Dividends or Splits Exhibits 2

• Actual Assumed Factor of
  Equivalent
• Months shares Shares Shares
  Year Whole
• are Outstanding Outstanding Outstanding
  Outstanding Units
• 1994
• Jan -Dec 5,000 12,000 12/12 12,000
• 
  (5,000 200 120)
• 1995
• Jan - May 10,000 12,000 5/12
  5,000
• (10,000 120)
• Jun - July 15,000 18,000 2/12
  3,000
• (15,000 120)
• Aug - Sept 18,000 18,000 2/12
  3,000
• Oct - Dec 20,000 20,000 3/12
  5,000
• 
  
  16,000

11
Earning Per Share Subtotals

• EPS is presented by the components of net income
  (i.e., EPS of continuing operations, EPS of
  discontinued operation), EPS of extraordinary
  items, EPS of cumulative effect due to change in
  accounting principle). Each of these EPS is based
  on the same weighted average number of shares and
  the components are summed to disclose the EPS of
  net income. The intent is to show the
  contribution of each component of net income to
  EPS.

12
Earning Per Share SubtotalsExhibit 3

• NORCAT CORPORATION
• Earning Per Share Disclosure
• Earning Per common share outstanding
• Income before extraordinary items 2.03
• Extraordinary loss (0.37)
• Net income 1.76
  

13
Earning Per Share Subtotals Exhibit 4

• ROBERTS CORPORATION
• Computation and Disclosure of Basic Earnings
• Per Share (Simple capital Structure)
• 1. Income statement information
• a. Net income for 1995 is 14,000.
• b. An extraordinary gain (net of income taxes)
  of
• 3,600 is included in net income.
• 2. Stockholders equity information (end of
  1995)
• a. 8 Preferred stock, 100 par 30,000
• b. Common stock, 10 par 60,000

14
Earning Per Share Subtotals Exhibit 4
(contd.)

• 3. Additional information
• a. No preferred stock was issued or reacquired
• during 1995.
• b. Preferred dividends were declared during 1995
• a the stated rate.
• c. A review of the common stock account shows
• that on January 1, 1995, 2,000 shares of
• common stock were outstanding. On April
  3,
• 400 shares of common stock were issued
  for
• cash. On June 1, a two-for-one stock
  split
• occurred, resulting in 5,000 total common
• shares. On November 2, 1,000 share of
• common stock are issued for cash.

15
Earning Per Share Subtotals Exhibit 4
(contd.)

• 4. Earnings per share computations for 1995
• Earnings Shares
  Earnings
• Explanation (Adjustments)
  (Adjustments) Per Share
• Net income 14,000
• Preferred dividends a (2,400)
• Common shares b
  4,917
• Earnings and shares 11,600 ? 4,917
  2.36
• a. Preferred dividends 30,000 0.08 2,400
• b. Weighted average shares
• 4,000 (2,000 200 stock split) 3/12
  1,000
• 5,000 (2,500 200) 7/12
  2,917
• 6,000 (2,500 2001,000) 2/12
  1,000
• Weighted average common shares
  4,917

16
Earning Per Share Subtotals Exhibit 4
(contd.)

• 5. Condensed income statement presentation for
  1995
• Income before extraordinary items 10,400
• Extraordinary gain (net of income taxes)
  3,600
• Net income 14,000
• Basic earnings per common share outstanding
• (see Note A)
• Income before extraordinary items 1.63
• Extraordinary gain
  0.73
• Net income 2.36

17
Note A to financial statements

• Preferred dividends of 2,400 are deducted from
  income before extraordinary items and net income
  to determine earnings available to common stock.
• The resulting amounts of 8,000 and 11,600
  divided by the 4,917 weighted average common
  shares yield 1.63 and 2.36 earnings per share,
  respectively.

18
Complex Capital Structure

• Many corporations capital structure includes
  convertible preferred stock, convertible bonds,
  stock options and warrants. Since conversion of
  these items into common stock would affect EPS,
  they are considered in computing EPS. Therefore,
  corporations with complex capital structures are
  required to present diluted earnings per share.
  

19
Diluted Earning Per Share

• In computing diluted EPS, the potential impact of
  common stock equivalents is considered in
  addition to the weighted average shares.

20
Diluted Earning Per Share (contd.)

• A common stock equivalent (C.S.E) is
• a security that is not a common stock,
• but that contains a provision enabling
• its holders to acquire common stock
• under predetermined terms which, at
• issuance, make it in substance
• equivalent to a common stock.

21
Diluted Earning Per Share (contd.)

• To be included in the diluted EPS
• calculation, the CSE must have
• dilutive effect on EPS (that is,
• decrease EPS). To evaluate the dilute
• effect of each security, it is necessary
• to include CSE in the diluted EPS
• calculation in a certain order.

22
Diluted Earning Per Share (contd.)

• The following sequence of steps should be
  followed
• Step 1 Compute the basic earnings per
• share.
• Step 2 Include dilutive stock options and
• warrants to compute a tentative
• diluted EPS.
• Step 3 Develop a ranking of the impact of
• each common stock equivalent
• (other than stock options and
• warrants) on DEPS.

23
Diluted Earning Per Share (contd.)

• The following sequence of steps should be
  followed
• Step 4 Include each common stock
• equivalent in DEPS in a sequential
• order based on the ranking and
• compute a new tentative DEPS.
• Step 5 Select the lowest tentative DEPS as
• the diluted EPS.

24
Diluted Earning Per Share Stock
Options and Warrants (step 2)

• Stock options and warrants are always considered
  to be common stock equivalents and are first to
  be included in the computation of dilution EPS.
  However, they will be included in the DEPS
  calculation only if they are dilutive (decrease
  DEPS). Stock options or warrants will be dilutive
  if the exercise of the options (or warrants) will
  result in an increase of common shares using a
  treasury stock method.

25
Diluted Earning Per Share Stock
Options and Warrants (step 2)(contd.)

• This method assumes that the options were
  exercised at the beginning of the period (or at
  the time of issuance if later) and that the
  assumed proceeds received from the exercise were
  used to reacquire the corporations common stock
  at the market price.

26
Diluted Earning Per Share Stock
Options and Warrants (step 2)(contd.)

• Under this treasury stock method, the number of
  shares added to the denominator in computing the
  EPS is the difference between the assumed shares
  issued (through the exercise of options) and the
  shares reacquired using the proceeds from the
  exercise of options (there is no charge in the
  numerator of EPS computation). Therefore,
  dilution occurs whenever the market price is
  greater than the option price.

27
Example

• Assume a corporation has 10,000 common shares and
  options to purchase 1,000 common shares at 20
  per share outstanding the entire year, and that
  the market price for the common stock was 25 per
  share. The net increase in the denominator would
  be 200 computed as follow

28
Example(contd.)

• Shares assumed issued through
• the exercise of options
  1,000
• Shares assumed acquired
• Proceeds 20 1,000 (800)
• Ave market price 25
• Assumed increase in common shares
• for computing DEPS
  200

29
Example(contd.)

• Therefore, the stock options are diluted and the
  200 assumed increased shares would be added to
  the denominator in computing a tentative diluted
  EPS.
• If common stock equivalents in the form of
  convertible bonds or convertible preferred stock
  also were outstanding, the DEPS, which included
  the options, would be only tentative and
  subject to the possible inclusion of the
  convertible securities.

30
Ranking of Common Stock Equivalents (CSE)

• Stock options and warrants always are considered
  to be CSE and are the first to be included (if
  they are dilutive) in DEPS computation. Other CSE
  (i.e., Convertible Securities) also are included
  in DEPS after stock options and warrants, but
  only if their inclusion also has a dilute impact
  on the EPS. A security that may appear to be
  individually dilute, in fact, maybe antidilutive
  in combination with other CSE. Therefore, a
  ranking is performed to determine the sequence in
  which the CSE should be included in the DEPS.

31
Ranking of Common Stock Equivalents (CSE)
(contd.)

• This ranking is determined by comparing the
  individual impact on EPS that result from the
  assumed conversion of each CSE into common shares
  at the beginning of the earliest period reported
  (or at the date of issuance of the security, if
  later). The assumed conversion has impacts on
  both numerator and denominator of DEPS. The
  denominator will be increased (due to the assumed
  conversion of CSE into common stock) and the
  numerator will also be increase (due to the
  decrease in interest expense or the savings on
  preferred dividends).

32
Ranking of Common Stock Equivalents (CSE)
(contd.)

• The numerical value impact on DEPS for each CSE
  is computed as
• Change in EPS Numerator
• Impact on DEPS --------------------------------
  -----
• Change in EPS Denominator
• The CSE with the lowest impact causes the least
  increase in the numerator relative to the
  increase in the denominator from the assumed
  conversion.

33
Ranking of Common Stock Equivalents (CSE)
(contd.)

• Therefore, the security with the lowest impact
  will cause the greatest decrease in DEPS and is
  the most diluted CSE, and is the first (after
  stock options and warrants) to be included in
  DEPS. The CSE with the lowest (highest) impact on
  DEPS is listed at the top (bottom) of the
  ranking. The CSE are sequentially entered into
  the DEPS computations based on the ranking
  (beginning with the CSE listed on the top of the
  ranking).
• Exhibits 5 illustrates the calculation of the
  development of ranking, assuming that Poston
  Company has four CSE outstanding the entire year.

34
POSTON CORPORATION Computation of Impact of
Common Stock

• A. Summary of Common Stock Equivalents
• Security Description
  .
• A 9 convertible preferred stock. Dividends
  of 5400 were declared during the year.
  The preferred shares are
  convertible into
• 3,000 shares of common stock.
• B 10 convertible bonds. Interest expense
  (net of income taxes) of 4,800 was
  recorded during the year. The bonds are
  convertible into 1,920 shares of
  common stock.

35
POSTON CORPORATION Computation of Impact of
Common Stock (contd.)

• Security Description
  .
• C 8 convertible preferred stock. Dividends of
  8,000 were declared during the year. The
  preferred shares are convertible into 5,000
  shares of common stock.
• D 7 convertible bonds. Interest expense (net
  of income taxes) of 6,300 was recorded during
  the year. The bonds are convertible into 3,150
  shares of common stock.

36
POSTON CORPORATION Computation of Impact of
Common Stock (contd.)

• B. Computations and Rankings
• Security Impact Order in Ranking
• A 5,400/3,000 2
• 1.80
• B 4,800/1,920
• 2.50 4
• C 8,000/5,000
• 1.60 1
• D 6,300/3,150
• 2.00 3

37
Computation of Tentative and Final DEPS.

• The CSE are sequentially included in the DEPS
  according to the Ranking (from the top to the
  bottom) to compute tentative DEPS. One CSE is
  included in the DEPS at a time to compute a
  tentative DEPS and the inclusion is cumulative.
  Thus, numerous tentative DEPS are obtained. The
  lowest tentative DEPS is the final DEPS.

38
Computation of Tentative and Final DEPS. (contd.)

• On principle, when the most recently calculated
  (current) tentative DEPS is greater than the
  previous tentative DEPS, the interation process
  can be stopped. The previous tentative DEPS is
  the lowest DEPS and thus, the final DEPS.
• The rest of CSE (including the current one) are
  all antidilutive CSE (the inclusion of these CSE
  will increase, not decrease DEPS). Exhibits 6
  illustrates the computation of DEPS

39
Computation of Tentative and Final
DEPS.Exhibit 6

• WATTS CORPORATION
• Computation of Primary and Fully Diluted
  Earnings Per Share (Comprehensive Illustration)
• 1. Income statement information (1997)
• a. Income before extraordinary items
  17,400
• Extraordinary loss (net of income taxes)
  (1,500)
• Net income 15,900
• b. The effective income tax rate is 30.

40
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• 2. Balance sheet information
• a. 6,000 shares of common stock were
  outstanding the entire year. The stock sold
  at market price of 25 per share.
• b. Options to purchase 800 shares of common
  stock at 20 per share were outstanding the
  entire year.
• c. 7.5, 100 par convertible preferred stock,
  16,000 par value (and issuance price), were
  outstanding the entire year. 1,200 dividends
  were declared on the stock in 1997.

41
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• d. 9, 100 par convertible preferred stock,
  10,000 par value (issued at 112), were
  outstanding the entire year. 900 dividends
  were declared on the stock in 1997.
• e. 6 convertible bonds, 30,000 face value,
  were outstanding the entire year. The bonds
  were issued for 32,000, a price that yield
  5.4. Bond interest expense of 1,720 was
  recorded in 1997 the total premium is being
  amortized at the rate of 80 per year. Each
  1,000 bond is convertible into 19 shares of
  common stock.

42
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• f. 9.2 convertible bonds, 25,000 face value,
  were outstanding the entire year. The bonds
  were issued at 23,750, a price that yielded
  9.7 when the average Aa corporate bond yield
  was 14. Bond interest expense of 2,350 was
  recorded in 1997 the total discount is
  being amortized at the rate of 50 per year.
  Each 1,000 bond is convertible into 45
  shares of common stock.

43
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• 3. Impact on earning per share and resulting
  rankings
• Diluted
• Security Impact on EPS Ranking
• 7.5 Preferred 0.075 16,000 1.50
  2
• 160 5
• 9 Preferred 0.09 10,000 2.25
  4
• 100 4
• 6 Bonds (30,000 0.06) - 80 (1 - 0.3)
  2.11 3
• 30 19
• 9.2 Bonds (25,000 0.092) 50 (1 - 0.3)
  1.46 1
• 2.5 45

44
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• 4. Diluted earnings per share computation for
  1997
• Earnings Shares
  Earnings
• Explanation (Adjustments)
  (Adjustments) Per Share
• Basic earning and shares 13,8000a
  6,000 2.30 Basic
• Increment in shares (options)
  267b
• DEPS1 earnings and shares 13,8000 6,267
  2.20 DEPS1
• Saving in 9.2 bond interest
• expense 1,645C 1,123d
• Increment in shares
  7,392 2.09 DEPS2
• DEPS2 earnings and shares 15,445
• Savings in 7.5 preferred
• dividends 1,200e
• Increment in shares
  800f
• Diluted earnings and share 16,645g
  8,192h 2.03i Diluted

45
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• a.13,800 15,900 1,200 - 900
• b. 267 800 - 800 20
• 30
• c. 1645 (25,000 0.092) 50 (1 - 0.3)
• d. 1,125 2.5 bonds 45 common shares
• e. 1,125 25 bonds 45 common shares
• f. 1,200 0.075 16,000

46
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• g. 800 160 preferred shared 5 common shares
• h.The 6 convertible bonds and the 9 convertible
  preferred stocks are not included in diluted
  earnings per share because their impacts (2.11
  and 2.25, respectively) are greater than 2.03
  and each security is antidilutive.
• i. Diluted earnings per share related to income
  before extraordinary items equals 2.21 (16,645
  1,500 extraordinary loss) / 8,192 share.

47
Computation of Tentative and Final
DEPS.Exhibit 6 (contd.)

• 5. Condensed income statement presentation for
  1997
• Income before extraordinary items
  17,400
• Extraordinary loss (net of income taxes)
  (1,500)
• Net income 15,900
• Diluted earnings per share (see Note A)
• Income before extraordinary items
  (see Note A)
  2.21
• Extraordinary loss (.18)
• Net income 2.03

48
Note A

• Diluted earnings per share is based on 6,000
  average shares outstanding plus 2,192 incremental
  shares from giving effect to the assumed exercise
  of stock options and the conversion of two
  dilutive convertible securities, 9.2 convertible
  bonds and the 7.5 convertible preferred stock.
  Earnings available to common stockholders were
  adjusted accordingly. The remaining convertible
  are antidilutive and are not included in diluted
  earnings per share.

49
Additional Notes (EPS)

• 1.About 1/3 companies in the U.S. has convertible
  securities or warrants.
• 2.It convertible securities are Not issued till
  4/1/xx, the interest savings should be multiplied
  by 9/12. Also, the impact of the conversion on
  the weighted shares should also be multiplied by
  9/12.
• 3.If conversion rate is different for different
  period, choose the highest conversion rate.

50
Additional Notes (EPS)

• 4.Contingent issue agreementif all conditions
  for issuing additional shares are met, these
  shares should be included in the diluted EPS
  computation.
• This usually occurs in business combination.
• 5.Antidilutive convertible securities or warrants
  should NOT be included.