Preferred stock is not included in a company’s basic shares outstanding. That figure counts only common shares held by investors, and it’s what sits under basic earnings per share and market capitalization. Preferred stock affects those numbers from a different angle: its dividends come out of net income before EPS is calculated, and convertible preferred shares can enter the diluted share count. But the shares themselves stay outside the basic count.
What Basic Shares Outstanding Actually Counts
Basic shares outstanding is a count of common shares currently held by investors outside the company. Shares the company has bought back and holds in treasury are excluded. The number anchors two of the most-watched figures in investing: basic EPS uses it as the denominator, and market capitalization is share price multiplied by shares outstanding.
It isn’t a snapshot at quarter-end. Under U.S. GAAP, companies use a weighted-average number of common shares over the reporting period, which prevents a late-quarter issuance from distorting per-share results.1Deloitte Accounting Research Tool. 3.3 Weighted-Average Number of Shares Outstanding Only common shares go into that weighted average.
Why Preferred Stock Sits Outside the Count
Preferred stock represents a different economic interest than common stock. Common shareholders bear the residual risk of the business: when earnings rise they benefit, and when earnings fall they absorb the loss. Preferred shareholders hold a fixed claim. Their dividend doesn’t grow when the company thrives, and their liquidation preference is capped at a stated value. In exchange for that priority, most preferred stock carries no voting rights.2Securities and Exchange Commission. Description of Common Stock – Heritage-Crystal Clean, Inc.
Basic EPS is designed to measure what each unit of residual ownership earned during the period. Mixing preferred shares into the denominator would blur the line between fixed-claim holders and residual-claim holders, producing a number that reflects neither group’s economic reality. So the denominator is limited to weighted-average common shares, with no potential shares from convertible securities or options added in.1Deloitte Accounting Research Tool. 3.3 Weighted-Average Number of Shares Outstanding
How Preferred Stock Still Affects Per-Share Earnings
Even though preferred shares stay out of the denominator, they change the numerator. Before basic EPS is calculated, preferred dividends are subtracted from net income to arrive at “income available to common stockholders,” and that adjusted figure is what gets divided by weighted-average common shares.3Deloitte Accounting Research Tool. ASC 260-10 – Income Available to Common Stockholders A company reporting $10 million in net income with $1 million in preferred dividends has only $9 million available to common shareholders.
The type of preferred stock determines when the subtraction happens. With cumulative preferred stock, dividends accrue whether or not the board declares them, and the amount that would have accrued during the period is subtracted from net income for EPS purposes even in a year the company skips the payment.3Deloitte Accounting Research Tool. ASC 260-10 – Income Available to Common Stockholders With noncumulative preferred stock, only dividends actually declared during the period are subtracted.
That difference is easy to miss. A company with cumulative preferred stock outstanding will show a lower EPS even in years it doesn’t pay preferred dividends, because the obligation still accrues. Investors who ignore this can overestimate how much of a company’s earnings actually belong to them as common shareholders.
Convertible Preferred Stock and Diluted Share Counts
Convertible preferred stock is the one place where preferred shares enter a share count. Until the holder actually converts, the shares stay out of basic shares outstanding. But for diluted EPS, which shows what per-share earnings would look like if every convertible security and option were exercised, convertible preferred is folded in.
Accountants use the “if-converted” method. The calculation assumes the convertible preferred was converted into common shares at the start of the reporting period. Two adjustments happen at once: the denominator increases by the number of common shares the conversion would create, and the numerator adds back the preferred dividends that were subtracted for basic EPS, since those dividends would no longer exist after conversion.4PwC Viewpoint. 7.5 Diluted EPS
If diluted EPS comes in noticeably lower than basic EPS, convertible preferred is a meaningful piece of the capital structure and the potential dilution is worth tracking. One exception: if adding the convertible shares would push EPS up rather than down, GAAP treats the security as “anti-dilutive” and leaves it out of the diluted calculation. The rule is built to show worst-case dilution, not a flattering number.
The Substance-Over-Form Exception
There’s one situation where preferred stock does land in basic shares outstanding: when it’s preferred in name only. GAAP requires companies to evaluate the substance of a security, not just its legal label. A security legally structured as preferred stock that carries no meaningful liquidation preference and participates in the same economics as common stock should be treated as a class of common stock for EPS purposes.1Deloitte Accounting Research Tool. 3.3 Weighted-Average Number of Shares Outstanding
The reverse also applies. A security with the legal form of common stock but a substantive preference that makes it behave like preferred stock should not be counted as an outstanding common share. This shows up rarely, but when it does, it changes the per-share math. Reading the terms of the security matters more than trusting the label.
Where Preferred Stock Appears on the Balance Sheet
Preferred stock stays off the shares outstanding count but sits prominently on the balance sheet. Its placement depends on the terms. Perpetual or non-redeemable preferred stock is listed within stockholders’ equity, typically as a separate line item above common stock, presented at par or stated value. Mandatorily redeemable preferred stock is classified as a liability, because the company has a binding obligation to buy it back.5PwC Viewpoint. 5.6 Preferred Stock Contingently redeemable preferred stock sits in “mezzanine equity,” a section between liabilities and stockholders’ equity, used when the stock is redeemable on an event outside the company’s control or at the holder’s option.
Companies also disclose the liquidation preference of each preferred issue on the face of the balance sheet. When you’re sizing up the equity backing common shares, subtract the liquidation value of any preferred stock from total stockholders’ equity. The remainder is what actually stands behind the common shares that make up shares outstanding.