Earnings per share is a financial ratio that communicates a company's profitability. Analysts calculate earnings per share by dividing net income by the weighted average number of outstanding shares of a common stock. The weighted average number of shares considers the number of shares outstanding throughout the year, along with the length of time each share was outstanding. In order to calculate this number, the analyst needs to know the beginning number of shares outstanding and each common stock transaction that occurred during the year.
1. Find the number of shares of common stock outstanding at the beginning of the year. Review the stockholder equity section of the prior year's company balance sheet. The common stock should include a note which communicates the total number of shares outstanding at the end of the year. The number of shares outstanding at the end of the prior year equals the number of outstanding shares at the beginning of the current year.
2. Identify all transactions that changed the number of shares outstanding throughout the year. These include stock sales, stock retirements, stock splits or stock dividends.
3. Determine how each transaction impacted the total number of shares. Stock sales, stock splits and stock dividends increase the total number of shares. Stock retirements and reverse stock splits decrease the total number of shares.
4. Create a list of stock share balances. Start by writing the beginning balance of outstanding shares. Add each transaction on a new line. On each line, enter the increase or decrease in the number of shares and calculate the new total of outstanding shares. Calculate the number of days between each transaction. The number of days indicates how many days each balance applied.
5. Calculate the weighted average number of outstanding shares. Multiply the number of days by the total number of outstanding shares for each item on the list. Add the total of these numbers. Divide the total number of outstanding shares by the number of days in the year, or 365.
- Know the difference between a weighted average and a simple average. A weighted average considers the length of time each balance existed during the year. A simple average adds the beginning and ending balance, and divides them by two.