Diluted Earnings Per Share (EPS)
A 'Worst-Case' View of Per-Share Profitability
Diluted Earnings Per Share (EPS) is a measure of a company’s earnings per share calculated under the assumption that all potential shares (from convertible securities) have been converted into common stock. In other words, it answers the question: “What would our EPS be if every security that could turn into a share did turn into a share?” This makes diluted EPS a more conservative figure, since it usually comes out lower than the regular (basic) EPS by accounting for a larger number of shares. Dilution occurs because issuing more shares spreads the same earnings over a greater number of shares, reducing the earnings per share. Public companies typically report both Basic EPS and Diluted EPS on their income statements to give investors both figures for comparison.
How Diluted EPS Is Calculated
Diluted EPS starts with the company’s net income available to common shareholders (net income minus preferred dividends). It then increases the share count in the denominator to include all potential shares that could be issued from convertible securities.
Calculation Example: Basic vs. Diluted
Securities That Can Dilute EPS
These are known as dilutive securities—any security that can be converted or exercised into common stock. Common examples include:
- Stock Options and Warrants: These give holders the right to purchase common shares. If exercised, new shares are issued, increasing the total share count and diluting EPS.
- Convertible Bonds: These are corporate bonds that can be converted into a specified number of common shares. If converted, the company issues new shares, which lowers EPS.
- Convertible Preferred Shares: A type of preferred stock that can be exchanged for common shares. If converted, it increases the common share count.
Anti-Dilutive Securities
If a particular security would increase EPS instead of decreasing it (e.g., an out-of-the-money option), it is considered anti-dilutive and is usually excluded from the diluted EPS calculation.
Why Diluted EPS Matters to Investors
Diluted EPS is an important metric because it presents a more realistic and cautionary view of a company’s earnings per share. It shows the worst-case scenario for EPS if all convertible claims on the company’s equity were exercised. This matters because it reveals how existing shareholders’ ownership could be diluted in the future. A large gap between basic and diluted EPS signals a significant number of potential new shares, which may concern investors. Many analysts prefer looking at diluted EPS because it reflects the company’s future obligations to issue more shares, thus preventing an overly optimistic picture of EPS.
Diluted EPS vs. Basic EPS
It’s important to understand the distinction between basic and diluted EPS:
- Definition: Basic EPS considers only current common shares. Diluted EPS includes current shares plus all potential shares from convertible securities.
- Value Comparison: Because diluted EPS uses a higher share count, it will always be less than or equal to basic EPS.
- Investor Insight: Basic EPS shows current earnings per share, but may overstate it if dilution is likely. Diluted EPS gives a fuller, more conservative picture. A large gap between the two is a red flag for investors to investigate potential dilution.
Key Takeaways
Diluted EPS is a conservative profitability metric that shows earnings per share as if all convertible securities (like stock options and convertible bonds) were exercised.
It is calculated by dividing net income available to common shareholders by the diluted weighted average number of shares, which includes all potential new shares.
Diluted EPS will always be less than or equal to Basic EPS, as it spreads the same earnings over a larger number of shares.
A significant gap between Basic and Diluted EPS indicates a high potential for future dilution of existing shareholders' earnings.
Public companies are required to report both Basic and Diluted EPS on their income statements to provide a transparent view of per-share profitability.
Diluted Earnings Per Share (EPS)
A 'Worst-Case' View of Per-Share Profitability
Diluted Earnings Per Share (EPS) is a measure of a company’s earnings per share calculated under the assumption that all potential shares (from convertible securities) have been converted into common stock. In other words, it answers the question: “What would our EPS be if every security that could turn into a share did turn into a share?” This makes diluted EPS a more conservative figure, since it usually comes out lower than the regular (basic) EPS by accounting for a larger number of shares. Dilution occurs because issuing more shares spreads the same earnings over a greater number of shares, reducing the earnings per share. Public companies typically report both Basic EPS and Diluted EPS on their income statements to give investors both figures for comparison.
Table of Contents
How Diluted EPS Is Calculated
Diluted EPS starts with the company’s net income available to common shareholders (net income minus preferred dividends). It then increases the share count in the denominator to include all potential shares that could be issued from convertible securities.
Calculation Example: Basic vs. Diluted
Securities That Can Dilute EPS
These are known as dilutive securities—any security that can be converted or exercised into common stock. Common examples include:
- Stock Options and Warrants: These give holders the right to purchase common shares. If exercised, new shares are issued, increasing the total share count and diluting EPS.
- Convertible Bonds: These are corporate bonds that can be converted into a specified number of common shares. If converted, the company issues new shares, which lowers EPS.
- Convertible Preferred Shares: A type of preferred stock that can be exchanged for common shares. If converted, it increases the common share count.
Anti-Dilutive Securities
If a particular security would increase EPS instead of decreasing it (e.g., an out-of-the-money option), it is considered anti-dilutive and is usually excluded from the diluted EPS calculation.
Why Diluted EPS Matters to Investors
Diluted EPS is an important metric because it presents a more realistic and cautionary view of a company’s earnings per share. It shows the worst-case scenario for EPS if all convertible claims on the company’s equity were exercised. This matters because it reveals how existing shareholders’ ownership could be diluted in the future. A large gap between basic and diluted EPS signals a significant number of potential new shares, which may concern investors. Many analysts prefer looking at diluted EPS because it reflects the company’s future obligations to issue more shares, thus preventing an overly optimistic picture of EPS.
Diluted EPS vs. Basic EPS
It’s important to understand the distinction between basic and diluted EPS:
- Definition: Basic EPS considers only current common shares. Diluted EPS includes current shares plus all potential shares from convertible securities.
- Value Comparison: Because diluted EPS uses a higher share count, it will always be less than or equal to basic EPS.
- Investor Insight: Basic EPS shows current earnings per share, but may overstate it if dilution is likely. Diluted EPS gives a fuller, more conservative picture. A large gap between the two is a red flag for investors to investigate potential dilution.
Key Takeaways
Diluted EPS is a conservative profitability metric that shows earnings per share as if all convertible securities (like stock options and convertible bonds) were exercised.
It is calculated by dividing net income available to common shareholders by the diluted weighted average number of shares, which includes all potential new shares.
Diluted EPS will always be less than or equal to Basic EPS, as it spreads the same earnings over a larger number of shares.
A significant gap between Basic and Diluted EPS indicates a high potential for future dilution of existing shareholders' earnings.
Public companies are required to report both Basic and Diluted EPS on their income statements to provide a transparent view of per-share profitability.
Related Terms
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