How is Earnings Per Share (EPS) calculated?

Earnings Per Share (EPS) is calculated by taking the net income of a company, subtracting any dividends paid to preferred shareholders, and then dividing that result by the average number of common shares outstanding during the reporting period. This formula is vital because it provides a clear picture of a company's profitability on a per-share basis, which is useful for investors when comparing company performance over different time periods or against other companies.

The focus on preferred stock dividends ensures that the EPS reflects only the earnings attributable to common shareholders. By dividing by the average number of common shares outstanding, the calculation also accounts for any fluctuations in the number of shares, which can occur due to issuance or buybacks throughout the period. This method gives a more accurate representation of a company's earnings as it relates to the shareholders' equity.

Other choices do not accurately reflect the EPS calculation. For example, dividing net income by total assets mixes profitability with asset management, and dividing total revenue by common shares does not consider expenses or preferred dividends, leading to an incorrect assessment of earnings available to common shareholders. Simply adding preferred stock dividends to net income does not provide a per-share metric and overlooks the number of common shares in calculating the earnings available to them.