What Is Diluted EPS?

What Is Diluted EPS?

Earnings per share (EPS) helps measure a company's profitability. Diluted EPS is considered a conservative metric because it indicates reduced earnings per share (EPS) when all convertible securities are exercised. Convertible securities include preferred shares, debentures, stock options, and warrants.

EPS vs. Diluted EPS

EPS compares the company's net earnings against its outstanding number of shares. Calculating diluted EPS includes future shares that a company may be obligated to issue. Dilutive securities include convertible preferred stock, stock options, and convertible bonds. If all of these securities were exercised, it would increase the number of outstanding shares and dilute EPS:

• Convertible preferred stock shares can be converted to common shares at any time.
• Stock options grant the buyer the right to purchase a specified quantity of common stock at a set price. Stock options have an expiration date, and typically cannot be exercised before a vesting date.
• Convertible bonds are similar to convertible preferred stock as they are converted to common shares at a conversion rate dependent on how long the bonds have been held.
  

Formula and Calculation

A basic EPS equals the company's net income minus preferred dividends, divided by the weighted- average of outstanding common shares.

To calculate diluted EPS, include 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, in the weighted average with the outstanding common shares.

Example of Diluted EPS

Company ABC has the following financial data:

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. 

What EPS Tells Investors

Earnings per share is a metric to assess a company's financial health. Public companies must report EPS on their income statement and include both primary and diluted EPS.

Diluted EPS indicates a worst-case scenario that reflects the consequence of all dilutive shares such as options, warrants, and convertible preferred shares, converted simultaneously. The potential for dilution of the company's shares may concern analysts and investors.

For example, if Company A has $9 billion in outstanding shares and a $0.10 difference between its basic EPS and diluted EPS, that calculates to $900 million in potential new common shares and dilution.

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. Publicly traded companies must report both EPS and diluted EPS on their earnings report.