How Dividends on Preferred Stock Affect the Computation of EPS

by Kathy Adams McIntosh

Investors consider several aspects of a company's performance when they decide whether to buy stock in that company. They consider the company's short-term profitability as well as long-term sustainability. Earnings per share, or EPS, represents a measure of the company's profitability for a specific period of time. Investors calculate earnings per share using preferred stock dividends, net income and the number of outstanding shares of common stock.

Earnings Per Share

Each share of common stock represents an equal portion of ownership in the corporation. For example, if a company issues 100 shares of common stock, each share represents 1 percent ownership in the company. An investor who owns more shares of stock in the company owns a greater percentage of the company. Earnings per share determines the amount of income earned by the company that is attributable to each share of stock. Investors compare earnings per share to determine which companies earn a greater profit for each share of stock issued.

Preferred Dividends

Preferred stockholders purchase a separate class of stock that has different characteristics than common stock. Preferred stock includes a specified dividend rate, and preferred stockholders have with the right to receive their dividends before common stockholders do.

Reason

Earnings per share considers the net earnings of the company. Revenues minus expenses equals net earnings. Preferred dividends represent a return of equity to the preferred stockholders, not an expense. Investors calculate earnings per share in regard to common stock. The calculation for earnings per share considers the impact of preferred stock dividends because those dividends must be paid before common stockholders receive any of the company's earnings.

Calculation

Investors calculate earnings per share by determining the net income, the dividends paid to preferred stockholders, and the number of outstanding shares of common stock. The investor finds the net income figure from the income statement, the preferred dividends paid from the statement of cash flows, and the number of outstanding shares of common stock from the balance sheet. She then subtracts the preferred dividends from the net income, and divides this amount by the number of outstanding shares.

About the Author

Kathy Adams McIntosh started writing professionally in 2001. She has been published in "Cup of Comfort," "Community Connection" and "Wisconsin Christian News." Adams McIntosh belongs to the Fearless Freelancers and the Broadway Writers Guild. She earned her Master of Business Administration from the University of Wisconsin.