A company's diluted earnings per share is lower than its basic earnings per share because diluted earnings per share takes into account the total common shares outstanding and all convertible securities. Basic earnings per share only takes into account the total common shares outstanding.
The basic earnings per share (EPS) is calculated by dividing a company's net income minus any preferred dividends by the weighted average number of total common shares outstanding. For example, assume company ABC had a net income of $15 million during this fiscal year. The company paid out $3 million in preferred dividends and has 8 million shares outstanding. The resulting basic EPS is $1.50 (($15 million - $3 million) / 8 million) per share.
On the other hand, diluted EPS includes any convertible securities, which could dilute a company's common shares. Therefore, diluted EPS is almost always lower than basic EPS. Diluted EPS is calculated by dividing a company's net income minus preferred dividends by any securities that can be converted to common shares.
If a company has any convertible securities, such as stock options, warrants and convertible debt, the denominator of the diluted EPS will be larger than the denominator of the basic EPS. Therefore, the resulting diluted EPS is less than the basic EPS.
For example, assume company ABC has stock options and warrants that could be potentially converted to 10 million common shares. Therefore, company ABC's diluted EPS is 67 cents (($15 million - $3 million) / (8 million + 10 million)).