EPS Question

CFA Level I FRA
#1

When computing the Basic EPS, don’t we have to account for the weighted average outstanding shares? I’ve just seen an exercise on Schweser where it does not account for the time-difference of a 10% stock dividend paid on March, 31st.

Thanks in advance.

#2

Yes, the denominator in Basic EPS is WACSO.

Where can we find this exercise of which you speak?

#3

Schweser practice exams 2012, volume 1, Exam 2-Afternoon session, question 51.

Thanks man

#4

stock dividend is applied to the entire stock count available at that time. it’s not time dependent.

#5

So let’s say you have 2,000,000 shares outstanding on January 1st, and a 10% stock dividend is paid on April 1st. Nothing else. For me the WACSO would be 2,000,000 (outstanding the whole year) + 200,000*9/12 (outstanding 9 months out of 12). Opinions?

#6

Is the answer 2,000,000 * 1.01 = 2,200,000.

#7

Yup: 2.2 million; the stock split is retroactive.

#8

You mean stock dividend right? So what you mean by retroactive is that it is computed as if the shares had been issued on 1st of January?

#9

My mistake: stock dividend. (Although, there is no fundamental difference between a stock split and a stock dividend: a 10% stock dividend is really just an 11:10 stock split.)

When I say it’s retroactive, I mean that you need to change all of the outstanding shares numbers from the beginning of the year to the date of the split/dividend.

Suppose that you had 100,000 shares outstanding on 1/1/XX, you issued 10,000 shares on 3/1/XX, you bought back 20,000 shares on 7/1/XX, and you had a 10% stock dividend on 9/1/XX. Because of the dividend, you change all of the previous numbers:

  • Initial shares outstanding on 1/1/XX: 110,000
  • Shares issued on 3/1/XX: 11,000
  • Shares purchased on 7/1/XX: 22,000
#10

Brilliant as always! Many thanks s2000magician!

#11

You’re too kind.

You’re quite welcome.

#12

S2000magician: Can you explain the reason why we take it retroactive? I really really don’t understand the logic/intuition behind it.

#13

In my mind, the easiest way to think about it is to imagine that the shares are colored: red, blue, green, whatever. Every time the company deliberately changes the value of the outstanding shares – stock split, reverse stock split, stock dividend – imagine that they’re trading one color of stock for another:

  • A 3:1 stock split gives you three shiny, new red shares for each dull, old green share that you used to own
  • A 1:5 reverse stock split gives you one shiny, new purple share for every five old, dull yellow shares that you used to own
  • A 10% stock dividend gives you eleven shiny, new blue shares for every ten old, dull orange shares that you used to own

When a company issues or buys shares, they’re monochrome: the latest color outstanding. When they compute WACSO so that they can compute EPS, they compute the weighted-average _ monochrome _ (last color outstanding) common shares outstanding (WA_ M _CSO?). Therefore, every time there’s a color change, they have to grab their crayons and recolor all of the old shares so that they can do a monochrome calculation at year’s end.

As of an e-mail I received late this morning, I’m apparently allowed to do this: here’s a link to an article I wrote about WACSO (it has colors and everything, and, I hope, will make this clearer):

http://financialexamhelp123.com/weighted-average-common-shares-outstanding-wacso/

#14

Thank you!

#15

You’re welcome.