As Rich-Poor GapWidens in the U.S.,Class Mobility Stalls - May 13, 2005
Those in Bottom Rung EnjoyBetter Odds in Europe;How Parents Confer an EdgeImmigrants See Fast Advance
By DAVID WESSEL Staff Reporter of THE WALL STREET JOURNAL
The notion that the U.S is a special place where any child can grow up to be president, a meritocracy where smarts and ambition matter more than parenthood and class, dates to Benjamin Franklin. The 15th child of a candle-and-soap maker, Franklin started out as a penniless printer's apprentice and rose to wealth so great that he retired to a life of politics and diplomacy at age 42.
The promise that a child born in poverty isn't trapped there remains a staple of America's self-portrait. President Bush, though a riches-to-riches story himself, revels in the humble origins of some in his cabinet. He says his attorney general "grew up in a two-bedroom house," the son of "migrant workers who never finished elementary school." He notes that his Cuban-born commerce secretary's first job for Kellogg Corp. was driving a truck; his last was chief executive.
But the reality of mobility in America is more complicated than the myth.
As the gap between rich and poor has widened since 1970, the odds that a child born in poverty will climb to wealth -- or a rich child will fall into the middle class -- remain stuck. Despite the spread of affirmative action, the expansion of community colleges and the other social change designed to give people of all classes a shot at success, Americans are no more or less likely to rise above, or fall below, their parents' economic class than they were 35 years ago.
Although Americans still think of their land as a place of exceptional opportunity -- in contrast to class-bound Europe -- the evidence suggests otherwise. And scholars have, over the past decade, come to see America as a less mobile society than they once believed.
As recently as the late 1980s, economists argued that not much advantage passed from parent to child, perhaps as little as 20%. By that measure, a rich man's grandchild would have barely any edge over a poor man's grandchild.
"Almost all the earnings advantages or disadvantages of ancestors are wiped out in three generations," wrote Gary Becker, the University of Chicago economist and Nobel laureate, in 1986. "Poverty would not seem to be a 'culture' that persists for several generations."
But over the last 10 years, better data and more number-crunching have led economists and sociologists to a new consensus: The escalators of mobility move much more slowly. A substantial body of research finds that at least 45% of parents' advantage in income is passed along to their children, and perhaps as much as 60%. With the higher estimate, it's not only how much money your parents have that matters -- even your great-great grandfather's wealth might give you a noticeable edge today.Many Americans believe their country remains a land of unbounded opportunity. That perception explains why Americans, much more than Europeans, have tolerated the widening inequality in recent years. It is OK to have ever-greater differences between rich and poor, they seem to believe, as long as their children have a good chance of grasping the brass ring.
This continuing belief shapes American politics and economic policy. Technology, globalization and unfettered markets tend to erode wages at the bottom and lift wages at the top. But Americans have elected politicians who oppose using the muscle of government to restrain the forces of widening inequality. These politicians argue that lifting the minimum wage or requiring employers to offer health insurance would do unacceptably large damage to economic growth.
Despite the widespread belief that the U.S. remains a more mobile society than Europe, economists and sociologists say that in recent decades the typical child starting out in poverty in continental Europe (or in Canada) has had a better chance at prosperity. Miles Corak, an economist for Canada's national statistical agency who edited a recent Cambridge University Press book on mobility in Europe and North America, tweaked dozens of studies of the U.S., Canada and European countries to make them comparable. "The U.S. and Britain appear to stand out as the least mobile societies among the rich countries studied," he finds. France and Germany are somewhat more mobile than the U.S.; Canada and the Nordic countries are much more so.
Even the University of Chicago's Prof. Becker is changing his mind, reluctantly. "I do believe that it's still true if you come from a modest background it's easier to move ahead in the U.S. than elsewhere," he says, "but the more data we get that doesn't show that, the more we have to accept the conclusions."
Still, the escalators of social mobility continue to move. Nearly a third of the freshmen at four-year colleges last fall said their parents hadn't gone beyond high school. And thanks to a growing economy that lifts everyone's living standards, the typical American is living with more than his or her parents did. People today enjoy services -- cellphones, cancer treatment, the Internet -- that their parents and grandparents never had.
Measuring precisely how much the prosperity of Americans depends on advantages conferred by their parents is difficult, since it requires linking income data across many decades. U.S. research relies almost entirely on a couple of long-running surveys. One began in 1968 at the University of Michigan and now tracks more than 7,000 families with more than 65,000 individuals; the other was started by the Labor Department in 1966.
One drawback of the surveys is that they don't capture the experiences of recent immigrants or their children, many of whom have seen extraordinary upward mobility. The University of California at Berkeley, for instance, says 52% of last year's undergraduates had two parents who weren't born in the U.S., and that's not counting the relatively few students whose families live abroad.
Nonetheless, those two surveys offer the best way to measure the degree to which Americans' economic success or failure depends on their parents. University of Michigan economist Gary Solon, an authority in the field, says one conclusion is clear: "Intergenerational mobility in the U.S. has not changed dramatically over the last two decades."
Bhashkar Mazumder, a Federal Reserve Bank of Chicago economist, recently combined the government survey with Social Security records for thousands of men born between 1963 and 1968 to see what they were earning when they reached their late 20s or 30s. Only 14% of the men born to fathers on the bottom 10% of the wage ladder made it to the top 30%. Only 17% of the men born to fathers on the top 10% fell to the bottom 30%.
Land of the Self-Made Man
Benjamin Franklin best exemplified and first publicized America as the land of the mobile society. "He is the prototype of the self-made man, and his life is the classic American success story -- the story of a man rising from the most obscure of origins to wealth and international preeminence," one of his many biographers, Gordon S. Wood, wrote in 2004.
In 1828, a 14-year-old Irish immigrant named Thomas Mellon read Franklin's popular "Autobiography" and later described it as a turning point in his life. "Here was Franklin, poorer than myself, who by industry, thrift and frugality had become learned and wise, and elevated to wealth and fame," Mellon wrote in a memoir. The young Mellon left the family farm, became a successful lawyer and judge and later founded what became Pittsburgh's Mellon Bank. In front, he erected a statute of Franklin.
Even Karl Marx accepted the image of America as a land of boundless opportunity, citing this as an explanation for the lack of class consciousness in the U.S. "The position of wage laborer," he wrote in 1865, "is for a very large part of the American people but a probational state, which they are sure to leave within a longer or shorter term."
Self-made industrialist Andrew Carnegie, writing in the New York Tribune in 1890, catalogued the "captains of industry" who started as clerks and apprentices and were "trained in that sternest but most efficient of all schools -- poverty."
The historical record suggests this widely shared belief about 19th-century America was more than myth. "You didn't need to be told. You lived it. And if you didn't, your neighbors did," says Joseph Ferrie, an economic historian at Northwestern University, who has combed through the U.S. and British census records that give the occupations of thousands of native-born father-and-son pairs who lived between 1850 and 1920. In all, more than 80% of the sons of unskilled men moved to higher-paying, higher-status occupations in the late 1800s in the U.S., but less than 60% in Britain did so.
The biggest factor, Mr. Ferrie says, is that young Americans could do something most British couldn't: climb the economic ladder quickly by moving from farm towns to thriving metropolises. In 1850, for instance, James Roberts was a 14-year-old son of a day laborer living in the western New York hamlet of Catharine. Handwritten census records reveal that 30 years later, Mr. Roberts was a bookkeeper -- a much higher rung -- and living in New York City at 2257 Third Ave. with his wife and four children.
As education became more important in the 20th century -- first high school, later college -- leaping up the ladder began to require something that only better-off parents could afford: allowing their children to stay in school instead of working. "Something quite fundamental changed in the U.S. economy in the years after 1910 and before the Great Depression," says Prof. Ferrie.
One reason that the once-sharp differences between social mobility in the U.S. and Britain narrowed in the 20th century, he argues, is that the regional economies of the U.S. grew more and more similar. It became much harder to leap several rungs of the economic ladder simply by moving.
The paucity of data makes it hard to say how mobility changed for much of the 20th century. Individual census records -- the kind that Prof. Ferrie examines -- are still under seal for most of the 20th century. Data from the two national surveys didn't start rolling in until the 1970s.
Whatever the facts, the Franklin-inspired notion of America as an exceptionally mobile society persisted through most of the 20th century, as living standards improved after World War II and the children and grandchildren of immigrants prospered. Jeremiads in the 1960s and 1970s warned of an intractable culture of poverty that trapped people at the bottom for generations, and African-Americans didn't enjoy the same progress as whites. But among large numbers of Americans, there was little doubt that their children would ride the escalator.
Old Wisdom Shatters
In 1992, though, Mr. Solon, the Michigan economist, shattered the conventional academic wisdom, arguing in the American Economic Review that earlier studies relied on "error-ridden data, unrepresentative samples, or both" and misleadingly compared snapshots of a single year in the life of parent and child rather than looking over longer periods. There is "dramatically less mobility than suggested by earlier research," he said. Subsequent research work confirmed that.
As Mr. Mazumder, the Chicago Fed economist, put it in the title of a recent book chapter: "The apple falls even closer to the tree than we thought."
Why aren't the escalators working better? Figuring out how parents pass along economic status, apart from the obvious but limited factor of financial bequests, is tough. But education appears to play an important role. In contrast to the 1970s, a college diploma is increasingly valuable in today's job market. The tendency of college grads to marry other college grads and send their children to better elementary and high schools and on to college gives their children a lasting edge.
The notion that the offspring of smart, successful people are also smart and successful is appealing, and there is a link between parent and child IQ scores. But most research finds IQ isn't a very big factor in predicting economic success.
In the U.S., race appears to be a significant reason that children's economic success resembles their parents'. From 32 years of data on 6,273 families recorded by the University of Michigan's long-running survey, American University economist Tom Hertz calculates that 17% of whites born to the bottom 10% of families ranked by income remained there as adults, but 42% of the blacks did. Perhaps as a consequence, public-opinion surveys find African-Americans more likely to favor government redistribution programs than whites.
The tendency of well-off parents to have healthier children, or children more likely to get treated for health problems, may also play a role. "There is very powerful evidence that low-income kids suffer from more health problems, and childhood health does predict adult health and adult health does predict performance," observes Christopher Jencks, a noted Harvard sociologist.
Passing along personality traits to one's children may be a factor, too. Economist Melissa Osborne Groves of Maryland's Towson University looked at results of a psychological test for 195 father-son pairs in the government's long-running National Longitudinal Survey. She found similarities in attitudes about life accounted for 11% of the link between the income of a father and his son.
Nonetheless, Americans continue to cherish their self-image as a unique land where past and parentage puts no limits on opportunity, as they have for centuries. In his "Autobiography," Franklin wrote simply that he had "emerged from the poverty and obscurity in which I was born and bred to a state of affluence." But in a version that became the standard 19th-century text, his grandson, Temple, altered the words to underscore the enduring message: "I have raised myself to a state of affluence..."
Understanding Profit Margins
Types of MarginTo understand the differences between the three major types of margin, it helps to break down a company's expenses into three parts. First, there is the cost of goods sold, or cost of revenues. This represents the expenses most directly involved in creating revenue, such as raw materials and labor costs for a manufacturer or the wholesale price of goods for a retailer.
Subtracting cost of goods sold from revenue gives gross income, and dividing that figure by revenue gives gross margin. This number is close to most people's intuitive notion of profit margin. For example, if it costs you $8 to make a widget and you sell it for $10, your gross margin is $2 divided by $10, or 20%.
But any business of a reasonable size will also have expenses that are less directly involved in creating revenue. These are called operating expenses and include costs for marketing, research and development, and administrative salaries--more peripheral expenses that are nonetheless necessary for the company's everyday operations and that are particularly necessary for the company to grow. Subtracting both cost of goods sold and operating expenses from revenue gives you the company's operating income.
Operating margin equals operating income divided by revenue. This figure provides a more accurate picture than gross margin of how profitable a company's overall day-to-day operations are. In our example, suppose you spend $1 to advertise your widget; that cuts your 20% gross margin down to a 10% operating margin.
Finally, there are expenses that are not related to the day-to-day operations of the company but that have to be accounted for: costs such as interest expense, taxes, and some noncash charges such as write-offs. Subtracting these expenses from operating income results in net income, which in turn is used to calculate net margin. This is the margin figure you'll find in most sources of stock information, since it's the most accurate measure of how profitable a company is when everything is taken into account. If in the widget example, you have to pay $0.50 in tax on your $1.00 operating profit, you are left with a net margin of 5%.
How Margins InteractLooking at how these various margins relate to each other for a given company can be instructive. For example, consider Coca-Cola
KO and PepsiCo
PEP. In 1997, Coke's net margin was 21.9%, while Pepsi's was less than half that--10.2%. Most of that difference arose from Coke's higher gross margin of 68%, as opposed to Pepsi's 59%. Those are both good figures for the beverage industry, but Coke's legendary brand name allows it more pricing flexibility, while its exclusive focus on producing syrup--not bottling or making potato chips--keeps down the cost of goods sold. That translates into a significantly higher gross margin, and that 9% advantage in gross margin is magnified when operating expenses and taxes (similar for both companies) are taken out.
On the other end of the scale, consider Cott
COTTF, the Canadian company that makes discount private-label soft drinks for grocery stores. Cott's gross margin in 1997 was only 16%, a small fraction of Coke's and Pepsi's. But Cott's operating expenses were also much less, since it doesn't have a well-known brand to maintain and spends far less on sales and marketing than the two giants do. As a result, Cott posted a net margin of 2.5% in 1997. But profits are more precarious for a company with low gross margins, and Cott lost money in both 1996 and 1998.
Operating expenses are particularly important for retailers, whose gross margins are generally much lower than those of companies in other industries. Consider a couple of discount retailers, Wal-Mart
WMT and Kmart
KM. Wal-Mart's gross margin in 1997 was lower than Kmart's (20.4% versus 21.8%), because of its policy of keeping prices as low as possible. But Wal-Mart's net margin was more than three times higher (2.9% versus 0.8%), because its operating expenses were significantly lower than Kmart's.
Next, consider the leading Web retailer, Amazon.com
AMZN. Amazon's gross margins have been about 20% every year; that's significantly lower than those of its main competitors, Borders
BGP and Barnes & Noble
BKS, which both have gross margins of about 30%. On top of that, Amazon's operating expenses (mostly marketing and sales) have been about 40% of revenues, giving the company a negative operating margin of 20% (that is, its operating losses are 20% of its revenues). Assuming that Amazon won't be able to boost its gross margin very much in the competitive environment of the Web, it would have to cut its operating expenses in half just to post a net profit. In comparison, Yahoo's
YHOO operating expenses ate up 60% of its revenues in the second half of 1998, but it still managed to post a net profit during that time because it had a gross margin near 90%. That doesn't necessarily mean that Yahoo is the better company; it just has a different business model that inherently makes higher gross margins possible.
By themselves, profit margins are only a first step in evaluating a company's profitability. But as one of the building blocks of returns on capital, profit margin is a very important number, and understanding the different kinds of margins and how they interact can give you deeper insight into how a company operates.
Price/Book and Price/Sales Ratios
Although P/E ratios get all the attention, there are other valuation measures which can be more useful in many cases. Two of the most common are price/book and price/sales ratios. Both appear on the Morningstar Stock Report.
In this session, we'll cover each ratio in-depth and discuss the benefits and limitations of each.
Price/Book RatioMany investors use price/book because they believe that earnings are more variable and subject to accounting shenanigans than book value is. Book value is what would be left over for shareholders if a company shut down its operations, paid off all of its creditors, collected from all of its debtors, and liquidated itself. It's a more tangible measure of value than earnings, because book value tells you what you might actually get paid for a company in cold, hard cash.
Even though book value is theoretically what shareholders would receive if the company were liquidated, this is rarely the case in practice. That's because the value of assets and liabilities can change substantially from when they are first recorded. For example, a railroad company that paid a few dollars for an acre of land out west 100 years ago would have a far more valuable property today. That acre of land, however, continues to sit on the company's balance sheet at the original purchase price.
It's important to think about a company's basic characteristics when you're looking at its P/B ratio. A good proportion of a manufacturing company's worth is tied up in inventory and machinery, which are relatively well reflected in its book value. A software company like Oracle
ORCL, on the other hand, has a lot of its worth tied up in intangible assets like patents, market share, and the talents of its programmers. Since intangible assets such as these aren't taken into account when book value is calculated, Oracle's book value isn't as good a measure of what shareholders would receive if the company were liquidated.
It's also important to keep a company's return on equity (ROE) in mind when looking at its book value. If a company can make high returns on its book value, a high P/B is probably no cause for alarm. For these companies, the "B" is simply more valuable, because the firm can use the book value more efficiently to generate profits. For example, the relationship between Microsoft's P/B and ROE is a telling measure of its operating efficiency. Microsoft commanded a P/B of 17 at the end of 1999 because it continually earns returns on shareholder equity of 25% or more--something that relatively few companies are able to do.
Price/Sales RatioPerhaps the biggest advantage of the price/sales ratio is that it is based on the difficult-to-manipulate sales figure. Also, because sales are generally more stable than earnings, price/sales (P/S) can be a good tool for sifting through cyclicals and other companies with fluctuating earnings.
Take a look at chemical company Du Pont
DD. Although its P/E was as low as 13 and as high as 29 between 1994 and 1999, its P/S stayed between 1.7 and 2.7. The P/S ratio is also helpful in evaluating firms with negative earnings--which is why it's become such a popular tool for evaluating Internet stocks, which are often far from making money.
Sounds pretty good, doesn't it? Bear in mind, however, that whereas a dollar of earnings means essentially the same thing regardless of what company is producing it, the value of a sales dollar varies quite a bit from firm to firm. This is because companies' profit margins, or the efficiency with which sales are translated into profits, are highly variable. A software company like Microsoft
MSFT is able to convert every dollar in sales into more than 30 cents of profit, but computer hardware manufacturer EMC
EMC is only able to wring about 20 cents in profits from each dollar of sales. So, each dollar of Microsoft's sales is more valuable than each dollar of EMC's. This is why, even though the two companies have roughly comparable growth rates, Microsoft's P/S ratio is 27 and EMC's P/S ratio is a much-lower 16.
The strong effect of profit margins on P/S ratios is why they tend to vary tremendously across industries. For example, the retailers in Morningstar's stock database had an average P/S of just 0.8 at the end of 1999. That's because the average net margin for these companies is only 4%--only four cents of every dollar they make in sales translates into profits. On the other end of the spectrum, the average software company in our database keeps 15 cents of each sales dollar. It shouldn't come as a surprise, then, to find out that software companies have a P/S of almost eight--
their sales dollars are simply worth a good deal more than those of the retailers are.
Because both price/book and price/sales ratios aren't really comparable across industries, they are best used when comparing similar companies with each other or the current valuation of a particular company with its historical levels. As long as you stick within these boundaries, these ratios are a useful addition to the toolbox of every investor.
Price/Earnings Ratio
Probably the most popular valuation measure used by investors is the price/earnings ratio, or P/E. Numerically, a P/E is the price of a stock divided by its earnings per share (EPS) during the past four quarters. For example, a $20 stock that has earned $1 per share during the past year has a P/E of 20. You can find a stock's P/E ratio on the Morningstar Stock Report.
A P/E measures a stock's valuation--its popularity, if you will--by showing what multiple of earnings investors think a stock is worth. The faster investors think a company will grow, the more they like its stock, and the more they are willing to pay for each dollar of its earnings. America Online
AOL boasted a P/E of more than 600 at the end of 1999 because investors expected supercharged growth. Airline stock UAL
UAL languished at a P/E of about 12 because of its cloudy prospects
First, you can compare a company's P/E with the P/Es of similar companies and see how it stacks up. Bear in mind, however, that there may be good reasons why the company you're looking at is cheaper or more expensive than its peers. Microsoft
MSFT, for example, sports a premium P/E relative to other software companies because of its dominant market position. Also, it could be the case that the entire industry is over- or undervalued, in which case the benchmark you're using isn't really a good measure. (For example, saying that an Internet stock is cheap relative to other Internet companies isn't really a ringing endorsement, since the entire industry has been overblown in recent years.)
The same caveats apply to comparing a company's current P/E with its historical valuations. Make sure that the company hasn't undergone fundamental changes, like selling off a division or buying a competitor, that would make historical comparisons less meaningful.
Another way of using P/E is to compare a company with the average P/E of the S&P 500 or some other benchmark. Although this type of comparison can offer a lot of insight into how a company is valued relative to a broader group of companies, make sure that you compare apples to apples. If you're looking at the P/E of a small-cap stock, for example, measure it against a small-stock benchmark such as the Russell 2000 index rather than the S&P 500, which is comprised of larger stocks.
Another tricky thing about P/Es is that the "E" part of the ratio can be slippery. A bad year for a company can take a big chunk out of earnings and thus jack up the P/E tremendously. For example, the P/E of temp company Olsten
OLS, was a whopping 40 because of a big one-time charge (for restructuring) in the second quarter of 1998. Without the charge, Olsten's P/E would have been 11, below the average for its sector.
P/E's Flip Side, Earnings Yield
One useful variant of P/E is earnings yield, or earnings per share divided by stock price, usually expressed as a percentage. Earnings yield is just the inverse of P/E (which is equal to stock price divided by earnings per share), so it moves in the opposite direction of P/E. A high earnings yield indicates a cheap stock while a low earnings yield indicates an expensive one. Many value-oriented mutual fund managers use earnings yield to identify bargain stocks.
Expressing the relationship as a percentage, as earnings yield does, is in some ways more illuminating than the traditional P/E. Earnings yield can be used for clear comparisons between companies and even between different asset classes. In fact, many mutual fund managers compare earnings yields with 10- or 30-year Treasury-bond yields to get an idea of how expensive stocks are. Indeed, some academic research indicates that over time earnings yield has been one of the better indicators for judging if the market is over- or undervalued.
Although the S&P 500's earnings yield hasn't topped the yield of the 30-year Treasury in years, stocks have still outperformed bonds because investors have been willing to pay ever-higher prices for earnings. The S&P 500's meager 3% earnings yield in 1999 (the inverse of its P/E of 33) reflects how optimistic the market is about its future earnings power. By contrast, a stock with a high earnings yield signals that the market currently expects little from it
Reading the Balance Sheet
The simplest part of the income statement, the revenue section, tells you how much money the company has brought in. Most often there is just a single number for each time period. Larger companies will sometimes break down revenues on the income statement according to business sector, geographic region, or products versus services. Other companies might provide this information in the notes to the financial statements. The revenue number is sometimes called sales, especially for retailers and manufacturers ExpensesCost of Sales. Also known as cost of goods sold,
this number represents the expenses most directly involved in creating revenue, such as labor costs, raw materials (for manufacturers), or the wholesale price of goods (for retailers). Large companies that combine manufacturing with services (IBM
IBM, for example) will sometimes break down this number into cost of goods sold and cost of services.
Gross Profit. This number is equal to revenues minus cost of sales. It doesn't appear on all income statements, but it can easily be calculated when it doesn't.
Selling, General, and Administrative Expenses (SG&A). This number, also known as operating expenses, includes items such as marketing, administrative salaries, and, sometimes, research and development. These more peripheral expenses are still necessary for the company's everyday operations and are particularly necessary for the company to grow. Sometimes marketing or research and development are broken out as separate line items.
Depreciation and Amortization. When a company buys an asset intended to last a long time, it amortizes the cost of that asset on its income statement; that is, it spreads out the cost over a period of years meant to represent the useful life of the asset (up to 40 years), subtracting part of this cost from its earnings each year. This number is usually included in operating expenses, but only occasionally is it broken out separately on the income statement. It’s always included in the cash-flow statement, though, so you can look there in order to see how much a company’s net income was affected by non-cash charges such as depreciation.
Nonrecurring Charges/Gains. Often, companies will have a one-time charge resulting from a restructuring or an acquisition. Sometimes, they will have a one-time gain resulting from the sale of a subsidiary. Most often, these charges are included with operating expenses, but sometimes they appear further down, after interest expense.
Operating Income. This number is equal to revenues minus cost of sales and all operating expenses. It appears as a separate line item on many, but not all, income statements.
Theoretically, it represents the profit the company made from its actual operations, as opposed to such things as interest income and one-time charges. In practice, companies often include nonrecurring expenses (such as write-offs) in figuring operating income, and it is necessary to look closely at the income statement to spot such cases.
Interest Income/Expense. Sometimes interest income and interest expense are listed separately, and sometimes they are combined into net interest income (or expense, as the case may be). In either case, this number represents interest the company has paid on bonds it has issued or received on bonds it owns. Some income statements have a separate line item for income after interest expenses but before taxes.
Taxes. Tax information is usually the last expense listed before net income.
ProfitsNet Income. This number represents (at least theoretically) the company's profit after all expenses have been paid, and thus it receives a lot of attention when companies release their quarterly results.
Preferred Dividends. Some companies issue preferred stock, which pays dividends at a specified rate (generally higher than the rate paid on common stock) but has no voting rights. Because preferred-stock dividends are paid before common-stock dividends, they are sometimes broken out as a separate line item after net income, followed by net income available to common shareholders.
Number of Shares (Basic and Diluted). This figure represents the number of shares used in calculating earnings per share; it represents the average number of shares outstanding during the reporting period (a quarter or a year). Basic shares include only actual shares of stock; diluted shares also include securities that could potentially be converted into shares of stock, such as stock options and convertible bonds. For companies that issue a lot of options (such as many technology companies), the number of basic shares can differ substantially from the number of diluted shares.
Earnings per Share (Basic and Diluted). This number, which represents net income divided by number of shares, usually gets the most attention when a company reports its quarterly or annual results. Basic earnings per share (or EPS) uses the basic number of shares for this calculation, and diluted earnings per share uses the diluted number of shares. The distinction is meant to show the effect of stock options, the expense of which otherwise doesn't show up on the income statement; the more options a company has issued, the lower its diluted earnings per share relative to its basic earnings per share. However, just increasing the number of shares only goes part of the way in showing this effect, since many options are very valuable. Thus, companies with a significant number of outstanding options are also required to calculate the fair value of these options, subtract this value from net income, and calculate earnings using this figure. They don't have to show this lower earnings per share figure on the income statement proper, but it can usually be found in the notes.
