What is Diluted EPS?

Diluted Earnings Per Share (EPS) is the amount of profit that a company earns per share of stock after adding all the possible dilutive securities to earnings. Diluted EPS means adding to the calculation of earnings per share, the possible dilution effect that would arise if all the convertible securities. This includes stock options and convertible bonds that are exercised. This is particularly important in the Indian market, where many companies have very complex capital structures. In this article, we will explain what is diluted EPS, its formula, and its calculation in detail.

Diluted EPS Formula and Calculation

 The diluted EPS formula for calculation is relatively simple. The calculation of EPS involves deducting all the preferred dividends from the company’s net income. Then the obtained value is divided by the total outstanding shares of the company, which also includes the dilutive shares. Here is the formula for calculating diluted EPS. 

Diluted EPS = net income − preferred dividend/weighted average outstanding + diluted securities

Open Demat Account

Your first step to enter share market

Get Started

* By signing up you agree to our Terms and Conditions

How to Calculate Diluted EPS

Following are the steps given on how to calculate Diluted EPS. 

• Step 1: Compute net income: Take net income from the firm.
• Step 2: Subtract preferred dividends: If the company issued preferred dividends, deduct these in cash.
• Step 3: Count outstanding shares: Record the total number of shares outstanding.
• Step 4: Include all convertible securities: All available shares are inclusive of stock options, warrants, or other convertible securities with total outstanding shares.

Example of Calculating Diluted EPS

Assume XYZ Ltd. is an Indian company and has the following financial statement.

• Net Income: ₹1,50,000
• Preferred dividends: ₹30,000
• Outstanding shares: ₹2,00,000
• Employee stock options: 50,000 that can become common stock.
• Convertible bonds: 30,000 that can also become common stock.

1. Compute Basic EPS

• Basic EPS = (net income - preferred dividends) / outstanding shares
• Basic EPS = (₹1,50,000 - ₹30,000) / 2,00,000 = 0.60 per share. 

2. Dilute EPS:

• Total shares to calculate diluted EPS = outstanding shares + employee stock options + convertible bonds
• Total Shares = 2,00,000 + 50,000 + 30,000 = 2,80,000
• Dilute EPS = (net income - preferred dividends) / total shares to calculate dilute EPS.
• Dilute EPS = (₹1,50,000 - ₹30,000) / 2,80,000 = 0.43 per share.

In this example, diluted EPS is less than the basic EPS for the fact that potential new shares resulting from stock options and convertible bonds have been accounted for.

Why is Diluted EPS Important?

It is crucial to determine diluted EPS for the following reasons: 

1. In-Depth Profitability Perspective: The diluted EPS provides a clearer picture of how much profit truly is available to shareholders after the effects of potential dilution through various financial instruments.
2. Investment Decision-Making: A company will have much better decision-making for investors who can have more information about how the company will perform in terms of effective earnings per share in the future, with the comparison between basic EPS and diluted EPS.
3. Market Perception: Companies with low diluted EPS are less favorable to investors as compared to those with high EPS. This is because diluted EPS implies that future earnings per share would be reduced upon the conversion of dilutive securities.
4. Regulatory Compliance: As in any other country, accounting standards for India demand reporting of diluted EPS to preserve transparency in financial reporting.
5. Risk Assessment: The risk of possible dilution can easily be determined by the assessment of diluted EPS. That would therefore influence the return on investment.

How Companies Use Diluted EPS

Diluted EPS can be reflected in the company's financial statement and suggest how their earnings are doing. This may impact the following: 

• Stock Prices: Investors generally react to diluted EPS numbers when evaluating a company's performance compared to the industry.
• Market Perception: When there is a wide difference between basic and diluted EPS, investors may perceive this as a sign that management will use more equity in the future.

Basic EPS vs Diluted EPS

Basic EPS vs diluted EPS refers to earnings per share based on outstanding shares versus potential shares from convertible securities. Here is a table that states the difference between Basic EPS and diluted EPS.

Conclusion
Diluted earnings per share reporting provides an actual representation of a company’s profits in terms of actual dilution that might or might not occur through various sources. You can find this financial metric for companies on a share market app. It is a helpful aspect of the reporting process. Given India's frequent issue of convertible securities for financing strategies or employee compensation plans, it may sometimes be critical for companies to use this important metric. Basic EPS and diluted EPS can help investors make their decisions more precisely, better evaluate the level of financial stability and potential growth of a company, and make informed decisions about investments.