One of the most widely “Kedcounselling stylistics is earning per shore of common stock, Everyone who buys 01 Mock in a corporation needs t know tho annul earnings per share,
Stock market pill arc quoted on u per-share basis, It’ you sure considering nestling in IBM stock at 1 price of 5100 per share, you need to know the turnings per share and the annual dividend per share in order to decide whether, this price i. reasonable. In other words, how much earning power and how much dividend income would you be getting for each share yo,u buy?
The relationship and stock price is expressed by the price earnings (pie) ratio. This ratio is polytheism current stock price divided by the earnings per share for the year (last four squander. (A pic ratio is not computed if the company has sustained a net loss for this period.) Pic ratios are of such interest to investors that they are published daily in the financial pages of major newspapers. Price-earnings ratios and other measures useful for evaluating financial performance are covered in.
Stock prices. actually reflect investors’ expectations of future earnings. The pie ratio. however, is based on the earnings over the past year. Thus. if investors expect earnings to increase substantially from current levels. the pie ratio will be quite high-perhaps 20, 30, or even more.
But if investors expect earnings to decline from current levels. the pie ratio will be quite low, say, 8 or less. A mature company with very stable earnings usually soils between la.and 12 times earnings. Thus the pie ratio reflects investors’ expectations or the company’s future prospects. I Let us now look more closely at the measurement that underlies the pie ratio minis per share.
Computing Earnings per Share To compute earnings per share. the common stockholders’ share of the company’s net income is divided by the average-number of common shares outstanding. Notice that the concept of earnings per share applies only to common stock preferred stockholders have nb claim to earnings beyond. the .populated preferred stock dividends.
Computing earnings per share is easiest when the corporation has Issued only common stock. and the number of outstanding shares has not changed during the year. In this case. earnings per share is equal to net income divided by the’ number of shares outstanding. Whit Happen.
If More Share. Are Issued? In many companies. however, the number of shares of stock outstanding changes one or more times during the year. If additional shares are sold during the year, or if shares of common stock are retired (repurchased from the shareholders), the computation of earnings per share Is based on the lighthearted number of share outs kindling
The weighted-average number of shares for the year Is determined by multiplying the number of shares outstanding by the fraction of .the year that number of shares outstanding remained unchanged. For example, assume that 100.000 shares of common stock were standout during the first nine months of 2001 and 140,000 shares during the last three months. The lncre se in shares outstanding resulted from the sale of 40.000 Ihare for cuh. The welted-average number of shares outstanding during 200 1 would be 110,000. determined as follows
The procedure gives more meaningful earnings per share data than if the total numbero! shares outstandlng at th end of the year were used in the calculations. The numerator in the earnings per share calculation is net income. which was earned over the entire accounting period (a year in this example). By using the’ weighted-average number of shares.
W recognize that the proceeds from the sale of the 40,000 additional shares were available to generate earnings only during the last three months of the year.’ Although the weighted-average number of shares outstanding must be used in earnings per share computations, this figure does not appear in the stockholders’ equity section of the balance sheet
A balance sheet prepared at year-end reports the actual number of shares outstanding at that date, regardless of when these shares were issued. Preferred Dividends and Earnings per Share When a company has preferred stock outstanding, the preferred stockholders participate in net income only to the extent of the preferred stock dividends. To determine the earnings applicable to the common stock, we first deduct from net income the amount of current year-preferred dividends.
The annual dividend on cumulative preferred stock is always deducted, even if not declared by the board of directors for the current year. Noncumulative preferred dividends are deducted only if declared.
To illustrate, let us assume that Tanner Corporation has 200,000 shares of common stock- and 10,000 shares of $6 cumulative preferred stock outstanding throughout the 2 When the number of shares outstanding changes as a result of a stock split stock dividend (discussed later in this chapter), the computation of the weighted-average number of shares outstanding should be adjusted retroactively rather than weighted for the period the new shares were outstanding.
Earnings per share data for prior years thus will be consistently stated in terms of the current capital structure ..