Definition
Diluted Earnings Per Share (Diluted EPS) represents the amount of earnings attributable to each share of common stock if all convertible securities, options, and warrants are converted to common stock. It is a more conservative measure than basic EPS, as it accounts for the possibility of dilution thereby providing a potentially lower EPS figure.
The formula for calculating Diluted EPS is:
\[ \text{Diluted EPS} = \frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Average Shares Outstanding} + \text{Dilutive Shares from Options, Warrants, and Convertibles}} \]
Examples
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Example with Convertibles:
- Company XYZ has a net income of $1,000,000.
- It has 2,000,000 shares outstanding.
- There are 100,000 employee stock options outstanding.
- Each option can be converted into common stock.
Basic EPS: \( \frac{1,000,000}{2,000,000} = $0.50 \mathrm{per share} \)
Diluted EPS:
\[ \frac{1,000,000}{2,000,000 + 100,000} = \frac{1,000,000}{2,100,000} \approx $0.476 \mathrm{per share} \] -
Example with Warrants:
- Company ABC has a net income of $500,000.
- 1,000,000 shares are outstanding.
- If there are 200,000 warrants which can be converted to common stock at a calculated conversion price.
Basic EPS: \( \frac{500,000}{1,000,000} = $0.50 \mathrm{per share} \)
Diluted EPS:
\[ \frac{500,000}{1,000,000 + 200,000} = \frac{500,000}{1,200,000} \approx $0.417 \mathrm{per share} \]
Frequently Asked Questions
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What is the difference between basic EPS and diluted EPS?
- Basic EPS considers only the currently outstanding common shares, whereas diluted EPS includes all potential shares that could dilute earnings per share.
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Why is diluted EPS important to investors?
- Diluted EPS provides a more conservative measure of a company’s earnings per share, considering the worst-case scenario of share dilution.
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How are dilutive securities different from anti-dilutive securities?
- Dilutive securities, when converted, reduce the EPS. Anti-dilutive securities, when converted, increase the EPS, hence are excluded in diluted EPS calculations.
Related Terms with Definitions
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Basic Earnings Per Share (EPS):
- A measure of the company’s profitability per outstanding share of common stock without considering convertible securities.
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Convertible Securities:
- Financial instruments, such as convertible bonds or preferred shares, that can be converted into a predetermined number of common shares.
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Stock Options:
- Contracts that grant employees or investors the right, but not the obligation, to buy or sell stock at a set price before the option expires.
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Stock Warrants:
- Instruments issued by companies that give the holder the right to purchase the company’s stock at a specific price within a certain timeframe.
Online References
- Investopedia: Earnings per Share (EPS) Explained
- TheStreet: Understanding Diluted EPS
- Nasdaq Glossary: Diluted Earnings Per Share
Suggested Books for Further Studies
- “Financial Statement Analysis and Security Valuation” by Stephen Penman
- “Valuation: Measuring and Managing the Value of Companies” by McKinsey & Company Inc.
- “Financial Reporting and Analysis” by Lawrence Revsine, Daniel Collins, and W.Bruce Johnson
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Accounting Basics: “Diluted Earnings Per Share” Fundamentals Quiz
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