Chartered Financial Analyst (CFA) Practice Exam Level 2

In the context of stock splits, what is the main effect on earnings per share (EPS)?

1. EPS increases proportionally

2. EPS decreases proportionally

3. EPS remains unchanged

4. EPS fluctuates based on market demand

The correct answer is: EPS decreases proportionally

In the context of stock splits, the main effect on earnings per share (EPS) is that EPS remains unchanged. A stock split increases the number of shares outstanding while proportionately reducing the price per share, but it does not affect the total earnings of the company. As a result, while the EPS calculation involves dividing net earnings by the number of shares outstanding, the overall earnings do not change due to a split. When a company conducts a stock split, it divides its existing shares into multiple shares. For example, in a 2-for-1 split, shareholders receive an additional share for each share they own, effectively doubling the number of shares. However, the company's overall earnings remain the same, so when calculating EPS after the split, the earnings divided by the new, larger number of shares result in the same EPS as before the split. Therefore, the correct understanding is that while the number of shares outstanding increases, the per-share earnings do not decrease or increase; they remain steady. This is a fundamental aspect of stock splits and is crucial for understanding their impact on financial metrics like EPS.