Companies that are subject to generally accepted accounting principles (GAAP) for financial reporting purposes must always disclose the diluted earnings per share (EPS) ratio on financial statements. The diluted EPS formula uses the weighted average of outstanding common shares as its denominator but increases it by the number of unvested restricted stock shares the company provides its employees with. The effect of increasing the denominator of the ratio with restricted stock shares always reduces EPS.
1. Obtain the balance of outstanding shares of common stock on the first day of the fiscal year. You can extract the outstanding share balance from most websites that provide free stock quotes or from the ending balances that companies report on financial statements for the prior fiscal year.
2. Identify each date the number of outstanding common shares changes and record the new balance. As companies issue new shares of stock to raise capital or buy back shares of stock, the balance of outstanding shares will change.
3. Calculate the number of months that each outstanding share balance covers. For example, suppose a corporation has 100 shares outstanding on January 1 and the only change occurs on March 1 when the company issues an additional 50 shares. The 100-share balance covers two months and the 150-share balance covers the remaining 10 months.
4. Multiply each balance by the percentage of the fiscal year it’s applicable. The percentage is equal to the ratio of the number of months the balance covers to 12 months in a year. For example, you will multiple the 100-share balance by one-sixth and the 150-share balance by five-sixths.
5. Sum the results to arrive at the weighted average of outstanding common shares. For basic EPS calculations that ignore the dilutive effect of restricted stock, the result is the denominator you can use for the EPS calculation.
6. Add the number of restricted stock shares to the weighted average outstanding shares. At the end of the fiscal year, the number of restricted stock shares equals the total number of shares that will vest in future fiscal periods. The result is the denominator for calculating diluted EPS.
- To complete the computation of diluted EPS, divide the net income the company reports for the period by the weighted average of outstanding shares after increasing it for the restricted stock.
- Restricted stock is a form of compensation that corporations provide their employees with. Since the employees don’t own the shares unless they continue their employment with the company through the vesting date, companies use awards of restricted stock as incentive for employees to remain working for the company.
- When evaluating the number of restricted stock shares, it’s important that you extract the balance as of the last day of the fiscal year to avoid double counting shares. Restricted stocks that vest during the fiscal year become ordinary outstanding shares and are reflected in the changes to the balance of outstanding common shares.
Items you will need
- Outstanding common stock on each date of the fiscal year
- Number of unvested shares of restricted stock at end of fiscal year