What Is Diluted EPS?
Diluted EPS is a measurement used to gauge the quality of a company's earnings per share (EPS) if all convertible securities were exercised. The diluted EPS is commonly lower than the simple or basic EPS.
Convertible securities are outstanding convertible preferred shares, convertible debentures, stock options, and warrants.
- Diluted earnings per share (EPS) is a measurement of a company’s earnings per share if all convertible securities were converted.
- Dilutive securities are securities that can be converted to common stock.
- Dilution devalues a shareholder's existing equity stake and reduces a firm's earnings per share.
- Diluted EPS is considered a conservative metric because it indicates a worst-case scenario in terms of EPS.
Earnings Per Share Explained
Understanding Diluted EPS
Earnings per share, or EPS, is a financial metric used to measure a company's profitability. It compares the company's net earnings against its current number of shares. Calculating diluted EPS includes shares that a company may be obligated to issue in the future.
Convertible preferred stock, stock options, and convertible bonds are common types of dilutive securities. All of these securities, if exercised, would increase the number of shares outstanding and decrease EPS.
Convertible preferred stock is a preferred share that can be converted to a common share at any time. Stock options grant the buyer the right to purchase common stock at a set price at a set time.
Convertible bonds are similar to convertible preferred stock as they are converted to common shares at the prices and times specified in their contracts.
Shareholders typically resist dilution as it devalues their existing equity stake and reduces a firm's earnings per share.
Formula and Calculation of Diluted EPS
A basic EPS takes the company's net income minus any preferred dividends and divides it by the number of outstanding shares.
To calculate diluted EPS, add the number of dilutive shares, or the number of shares that would exist if all of a company's existing potential share obligations were exercised.
For both calculations, it is best to use a weighted average of shares outstanding for the period.
Example of Diluted EPS
Company ABC has the following financial data:
|Net Income||Preferred Dividends||Outstanding Shares||Employee Stock Options||Convertible Bonds|
|$11 Million||$1 Million||$20 Million||5 Million Shares||15 Million Shares|
EPS = ($11 Million - $1 Million) / 20 Million Shares Outstanding
EPS = $.50 Per Share
Diluted EPS = ($11 Million - $1 Million) / (20 Million Shares Outstanding + 20 Million Dilutive Shares)
Diluted EPS = $.25 Per Share
Diluted EPS can provide a more accurate picture of a company's financial condition than ordinary EPS. Since many companies have obligations that could result in additional shares being issued, it is best to express financial metrics such as EPS using a diluted share count.
Diluted EPS vs. EPS
Earnings per share, the value of earnings per share of outstanding common stock, is an important metric used to assess a company's financial health.
EPS is reported on a company's income statement, and only public companies are required to include it in their earnings reports. Public companies report both primary and diluted EPS, but the focus is often on the conservative diluted EPS measurement.
Dilutive EPS indicates a worst-case scenario for earnings per share and reflects the consequence of all dilutive shares such as options, warrants, and convertible preferred shares, converted simultaneously.
A large difference between a company's basic EPS and diluted EPS can indicate the potential for dilution of the company's shares and is a concern for analysts and investors.
If Company A has $9 billion in outstanding shares and there is a $0.10 difference between its basic EPS and diluted EPS. it equates to $900 million in value unavailable to investors.
What Does a Diluted EPS Tell Shareholders?
Diluted EPS considers what would happen if dilutive securities were exercised. Dilutive securities are securities that are not common stock but can be converted to common stock if the holder exercises that option. If converted, dilutive securities effectively increase the weighted number of shares outstanding, which decreases EPS, thereby devaluing a shareholder's existing equity stake.
Is a High Diluted EPS Better Than a Low Diluted EPS?
Higher diluted EPS figures should obtain higher valuations from the market with investors more willing to pay a premium for each share of equity.
What Types of Companies Report Diluted EPS?
Only publicly traded companies are required to report both EPS and diluted EPS. Private companies are not required to report these figures.
The Bottom Line
Diluted EPS is a performance metric used to assess a company's earnings per share if all convertible securities were exercised. Dilution devalues a shareholder's existing equity stake and reduces a firm's earnings per share. Only publicly traded companies are required to report both EPS and diluted EPS on their earnings report.