Earnings per share (EPS) and diluted EPS are profitability measures used in the fundamental analysis of companies. EPS only takes into account a company's common shares, whereas diluted EPS takes into account all convertible securities such as convertible bonds or convertible preferred stock, which are changed into equity or common stock.
What Is EPS?
EPS measures the amount of a company's profit on a per-share basis. Unlike diluted EPS, basic EPS does not account for any dilutive effects that convertible securities have on its EPS. Dilutive effects occur when the number of shares increases, for example, through a new issue. If a company issues more shares to shareholders and other investors, this increases the number of shares outstanding and decreases the company's earnings per share. Ultimately, this can decrease the stock price.
The formula to calculate a company's basic EPS is its net income less any preferred dividends divided by the weighted average number of common shares outstanding. The weighted average is a measurement investors use to monitor the cost basis on the shares accumulated over a period of years.
EPS=Average outstanding sharesNet income−Dividends on preferred stock
Assume company ABCWXYZ had a net income of $50 million over the last fiscal year but did not pay any dividends and has common shares outstanding of 15 million.
Company ABCWXYZ's resulting EPS is
$15000000($50000000−0)=$3.33 per share
How Is Diluted EPS Different Than Basic EPS?
Conversely, diluted EPS is a metric used in fundamental analysis to gauge a company's quality of earnings per share assuming all convertible securities are exercised. Convertible securities include all outstanding convertible preferred shares, convertible debt, equity options (mainly employer-based options), and warrants.
The formula used to calculate a company's diluted EPS is a company's net income minus preferred dividends divided by the weighted average number of shares outstanding plus the impact of convertible preferred shares and the impact of options, warrants, and other dilutive securities.
Diluted EPS=(Average outstanding shares+Diluted shares)Net income−Dividends on preferred stock
For example, assume company ABCWXYZ has employee stock options that could be converted to 1 million common shares and convertible preferred shares that could be converted to 3 million common shares.
The resulting diluted EPS for company ABCWXYZ is
$15000000+$1000000+$3000000($50000000−0)=$2.63 per share
Generally, if a company has convertible securities, the diluted EPS is less than its basic EPS.