Diluted Earnings Per Share (EPS)
Diluted Earnings Per Share (EPS) is a financial metric that represents the portion of a company’s profit allocated to each outstanding Share of common Stock, including the potential dilution from convertible Securities, stock Options, and other sources. It provides a more conservative measure of earnings per share, considering the effect of all potential shares that could be created from financial instruments.
The formula for Diluted EPS is:
Diluted EPS = (Net Income – Dividends on Preferred Stock) / (Weighted Average Shares Outstanding + Dilutive Potential Shares)
Example: A company has a net income of $1 million and pays $100,000 in preferred dividends. It has 1 million shares outstanding and 200,000 potential shares from stock options and Convertible Bonds.
- Net Income: $1,000,000
- Preferred Dividends: $100,000
- Weighted Average Shares Outstanding: 1,000,000
- Dilutive Potential Shares: 200,000
Calculating Diluted EPS:
Diluted EPS = ($1,000,000 – $100,000) / (1,000,000 + 200,000) = $900,000 / 1,200,000 = $0.75
Case: If a company reports a basic EPS of $1.00 but has many convertible securities, the diluted EPS might be lower, indicating that if all potential shares were issued, existing shareholders would own a smaller percentage of the earnings.