Businesses and investors often consider the number of shares of common stock outstanding when evaluating a company. As the number of common shares outstanding increases, more investors will participate in company activities. These activities include voting on major company decisions and sharing dividend payments. Financial statement users use the weighted average number of shares of common stock outstanding to calculate the earnings per share, and this provides information about the company’s profitability.
Each share of common stock represents partial ownership in the business. Investors purchase common stock with anticipation of earning money on the investment. They earn money by selling the stock after it grows in value or by receiving regular income through dividend payments. If a company liquidates, the common stockholders divide all remaining assets after all company obligations are met. Common stockholders also receive the right to vote on major company decisions, such as potential mergers.
The number of outstanding shares refers to the total shares currently owned by stockholders. The company receives authorization from the Securities and Exchange Commission to issue a specified number of shares. Most companies only issue a limited amount of these shares at one time. After the company issues the shares to investors, those shares become outstanding. Occasionally a company purchases its own shares off the open market. These shares are called treasury stock and are removed from the total number of outstanding shares.
A weighted average considers the length of time each share is outstanding and calculates an average based on the timing. For example, if the company issues 10,000 shares on January 1 and an additional 5,000 shares on July 1, the company has a total of 15,000 shares outstanding on December 31. The weighted average considers that 10,000 shares were outstanding the entire year and 5,000 were only outstanding for half of the year.
To calculate the weighted average, the company multiplies each issuance by the number of months outstanding and totals these amounts. The total is divided by the total number of months. In this example, the company would multiply 10,000 by 12 months to arrive at 120,000. The company would multiply 5,000 by six months to arrive at 30,000. The total of these two calculations equals 150,000. The company divides 150,000 by 12 months to arrive at a weighted average number of common stock outstanding of 12,500.
Earnings Per Share
Earnings per share considers the money earned by the company throughout the year on a per-share basis. The financial statement user calculates the earnings per share by dividing the net income by the weighted average number of common shares outstanding.