Earnings Per Share (EPS) vs. Diluted EPS: An Overview
Earnings per share (EPS) and diluted EPS are profitability measures used in the fundamental analysis of companies. EPS 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.
- Earnings per share (EPS) take into account only common shares, while diluted EPS includes convertible securities, employee stock options, and secondary offerings.
- Dilutive effects occur when the number of shares increases—for example, through a new issue.
- Generally, if a company has convertible securities or employee stock options, there is the risk of EPS dilution.
- Because of this, many analysts prefer diluted EPS as a more comprehensive figure.
- Diluted EPS is always less than its basic EPS.
Earnings Per Share (EPS)
EPS measures the amount of a company’s profit on a per-share basis. Unlike diluted EPS, basic EPS does not account for the dilutive effects that convertible securities have on EPS.
Dilutive effects occur when the number of shares increases—for example, through a new share issue. If a company issues more shares to investors, then this increases the number of shares outstanding and decreases the company’s EPS. Ultimately, this can decrease the stock price.
To calculate a company’s basic EPS, take a company’s net income and subtract any preferred dividends, then divide the result by the weighted average number of common shares outstanding. The weighted average is a measurement that investors use to monitor the cost basis on shares accumulated over a period of years.
Conversely, diluted EPS is a metric used in fundamental analysis to gauge a company’s quality of EPS assuming all convertible securities have been exercised. Convertible securities include all outstanding convertible preferred shares, convertible debt, equity options (mainly employer-based options), and warrants.
To calculate diluted EPS, take a company’s net income and subtract any preferred dividends, then divide the result by the sum of the weighted average number of shares outstanding and dilutive shares (convertible preferred shares, options, warrants, and other dilutive securities).
Example of Earnings Per Share (EPS) vs. Diluted EPS
For example, assume Company ABC had $50 million in net income over the past year, but it did not pay any dividends and has 15 million common shares outstanding.
The resulting EPS for Company ABC is:
Now, assume that in addition to its 15 million shares outstanding, ABC grants employee stock options that could be converted to 1 million additional common shares and convertible preferred shares that could be converted to 3 million common shares.
The resulting diluted EPS for Company ABC is thus:
Generally, if a company has dilutive securities, then the diluted EPS is going to be less than its basic EPS.
Is EPS or Diluted EPS Better?
Earnings per share (EPS) is an important metric for understanding a firm's profitability. Because many companies have additional shares in reserve in the form of equity compensation, employee stock options, or convertible securities, diluted EPS provides a more comprehensive view of potential per-share profitability.
Why Is Diluted EPS Important?
Diluted EPS accounts for shares that are not yet outstanding but could be in the future. These can arise from convertible securities that are turned into common stock or via the exercising of employee stock options. Because actions like these will effectively increase the number of shares outstanding, they will also dilute the firm's overall profits when it is evaluated on a per-share basis. Knowing the fully-diluted EPS is therefore important for understanding how current shareholders may be impacted down the road.
What Does a Higher EPS Indicate?
A higher EPS, all else equal, is favorable as it represents increased profitability to the firm. One must check how many shares are outstanding and consider both historical EPS and forward projections in addition to current results.