Financial Ratios - Dilutive Securities

Dilutive Securities are securities that are not common stock in form, but allow the owner to obtain common stock upon exercise of an option or a conversion privilege. The most common examples of dilutive securities are: stock options, warrants, convertible debt and convertible preferred stock. These securities would decrease EPS if exercised or if they were converted common stock. In other words, a dilutive security is any securities that could increase the weighted number of shares outstanding.

If a security after conversion causes the EPS figure to increase rather than decrease, such a security is an anti-dilutive security, and it should be excluded from the computation of the dilutive EPS.

For example, assume that the company XYZ has a convertible bond issue: 100 bonds, $1,000 par value, yielding 10%, issued at par for the total of $100,000. Each bond can be converted into 50 shares of the common stock. The tax rate is 30%. XYZ's weighted average number of shares, used to compute basic EPS, is 10,000. XYZ reported an NI of $12,000, and paid preferred dividends of $2,000.

What is the basic EPS? What is the diluted EPS?

1) Compute basic EPS:
i. Basic EPS = (12,000 - 2,000) / (10,000) = $1.00

2) Compute diluted EPS:
i. Find the adjustment to the denominator: 100 * 50 = 5,000
ii. Find the adjustment to the numerator: 100 * $1000 * 0.1 * (1 - 0.3) = $7,000

3) Find diluted EPS:
i. Diluted EPS = (12,000 - 2,000 + 7,000) / 10,000 + 5,000 = $1.13

If the fully dilused EPS > basic EPS, then the security is antidilutive. In this case, Basic EPS = $1.00 is less than the fully diluted ESP, and the security is antidilutive.

Calculating Basic and Fully Diluted EPS in a Complex Capital Structure


Related Articles
  1. Forex Education

    The Dangers Of Share Dilution

    Investors need to be aware of the existence of dilutive securities and how they can affect existing shareholders.
  2. Fundamental Analysis

    Assess Shareholder Wealth With EPS

    Find out if management is doing its job of creating profit for investors.
  3. Markets

    The 5 Types Of Earnings Per Share

    A look at the five varieties of EPS and what each represents can help an investor determine whether a company is a good value, or not.
  4. Investing Basics

    The Dangers Of Share Dilution

    Share dilution reduces the value of an individual investment and can drastically impact a portfolio.
  5. Options & Futures

    Getting The Real Earnings

    EPS helps investors analyze earnings in relation to changes in new-share capital.
  6. Economics

    The 5 Types Of Earnings Per Share

    Understanding the many varieties of earnings per share will help investors make informed decisions.
  7. Bonds & Fixed Income

    ESOs: Dilution - Part 1

    By David Harper (Contact)Investors clearly care about the cost of employee stock options (ESOs), but they do not yet agree on the single best method for capturing the ESOs' economic cost. In ...
  8. Markets

    Investment Valuation Ratios

    Learn about per share data, price/book value ratio, price/cash flow ratio, price/earnings ratio, price/sales ratio, dividend yield and the enterprise multiple.
  9. Investing

    UPS Stock: An Earnings Case Study

    Check out the analysis of earnings for United Parcel Service, including historical earnings, past analyst estimates and future analyst estimates.
  10. Stock Analysis

    Boeing Stock: An Earnings Case Study (BA)

    Check out the earnings analysis for Boeing, including the company's historical earnings and analysts' past and future earnings estimates.
RELATED TERMS
  1. Basic Earnings Per Share

    A rough measurement of the amount of a company's profit that ...
  2. Diluted Earnings Per Share - Diluted ...

    Diluted Earnings Per Share (or Diluted EPS) is a performance ...
  3. Antidilutive

    A term describing the effects of securities retirement, securities ...
  4. Dilution Protection

    A provision that seeks to protect existing shareholders or investors ...
  5. Anti-Dilution Provision

    A provision in an option or a convertible security. It protects ...
  6. Dilution

    A reduction in the ownership percentage of a share of stock caused ...
RELATED FAQS
  1. What are the differences between dilutive securities and antidilutive securities?

    Learn how investors and accountants apply the terms "dilutive" and "antidilutive" to securities or the exercise of security ... Read Answer >>
  2. What is the difference between earnings per share (EPS) and diluted EPS?

    Learn about EPS and diluted EPS, what they measure, and the difference between the two. Read Answer >>
  3. Why should investors consider the fully diluted share amount?

    Learn about the importance of considering the fully diluted shares, how it could affect a stock's share price and how dilution ... Read Answer >>
  4. What are the best uses for trailing EPS, current EPS and forward EPS?

    The earnings per share (EPS) indicator has three basic types that can alert you to past, present and future health of a company. Read Answer >>
  5. What is the formula for calculating earnings per share (EPS)?

    Learn why earnings per share (EPS) is often considered to be one of the most important variables in determining a stock’s ... Read Answer >>
  6. What is the difference between an accretive transaction and a dilutive transaction?

    Read about the differences between an accretive and dilutive financial transaction, particularly as it pertains to a mergers ... Read Answer >>
Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center