Earnings Per Share: Calculating Basic and Diluted EPS

Readers likely agree that calculating earnings per share can be complicated, with differences between basic and diluted EPS.

This post explains the key differences between basic and diluted EPS, and provides clear steps for calculating both to accurately assess company performance.

You'll learn the specific formulas for basic and diluted EPS, see illustrative examples, and gain key takeaways for utilizing EPS analysis effectively.

Introduction to Earnings Per Share (EPS)

Earnings Per Share (EPS) is an important metric used by investors to assess a company's profitability on a per-share basis. By calculating EPS, investors can evaluate how much money a company earns for each outstanding share of its common stock. There are two main types of EPS - basic and diluted. Understanding the difference between basic and diluted EPS provides crucial insights into a company's financial health and performance.

What is Earnings Per Share (EPS)?

EPS refers to the portion of a company's net income that is allocated to each outstanding share of common stock. It serves as an indicator of profitability on a per-share basis. For example, if a company reports EPS of $2, that means it earned $2 for each share of common stock outstanding. The higher the EPS, the more profitable the company is on a per-share basis.

Why EPS Matters

EPS helps investors evaluate and compare profitability across companies. By standardizing earnings on a per-share basis, EPS enables easier comparisons of different companies regardless of the number of shares outstanding. EPS also indicates how much money the company makes for each share of its stock, which is useful for valuation analysis. Tracking EPS over time provides insight into the company's overall growth and financial health.

Understanding the Difference Between Basic and Diluted EPS

Basic EPS is calculated based only on the outstanding common shares of a company. Diluted EPS, on the other hand, takes into account securities that could potentially dilute EPS in the future, such as convertible bonds, warrants, and stock options. Diluted EPS provides a more conservative estimate of earnings power per share by assuming these dilutive securities have been converted into common shares, thereby increasing the share count. The difference between basic and diluted EPS gives investors clarity into future dilution and how it could impact shareholder value.

How do you calculate earnings per share basic and diluted?

A basic EPS takes the company's net income minus any preferred dividends and divides it by the number of outstanding shares. This gives investors an idea of how much money the company makes per share.

To calculate diluted EPS, you take into account all potentially dilutive securities. Dilutive securities are financial instruments that could be converted into common shares, like stock options and warrants.

When these dilutive securities are converted into common shares, there would be more shares outstanding. More shares outstanding leads to more dilution of earnings per share.

Here are the steps to calculate diluted EPS:

1. Calculate basic EPS (as shown above)
2. Determine potentially dilutive securities like stock options, warrants, convertible bonds
3. Calculate shares outstanding if all dilutive securities were converted
4. Add the dilutive shares to regular shares outstanding
5. Recalculate EPS with the new share count

Diluted EPS gives investors an idea of what EPS would be if all dilutive securities were exercised. Companies have to report both basic and diluted EPS on their financial statements.

Comparing basic vs diluted EPS also gives insight into how much dilution is caused by dilutive securities overall. The smaller the difference between basic and diluted EPS, the less dilution there is from dilutive securities.

How do you calculate basic earnings per share?

The formula for calculating basic earnings per share (EPS) is:

Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Number of Common Shares Outstanding

Where:

• Net Income: The company's total net income for the period
• Preferred Dividends: The dividends paid to preferred shareholders over the period
• Weighted Average Number of Common Shares Outstanding: The weighted average number of common shares outstanding over the reporting period

To calculate the weighted average number of shares outstanding:

1. Determine the number of shares outstanding at the beginning of the period (beginning balance)
2. Account for any new shares issued during the period
3. Subtract any shares repurchased by the company during the period (share buybacks)
4. Weight the shares based on the fraction of the period they were outstanding

For example, if a company had 100 million shares outstanding at the beginning of the year, issued 20 million new shares midway through the year, and repurchased 10 million shares in the last quarter, the weighted average number of shares would be:

(100 million x 12/12 months) + (20 million x 6/12 months) - (10 million x 3/12 months) = 110 million shares

So if net income was $50 million and preferred dividends were $2 million, basic EPS would be:

Basic EPS = ($50 million - $2 million) / 110 million shares = $0.45 per share

The key things to remember when calculating basic EPS:

• Only common shareholders are included
• Shares are weighted based on the time they were outstanding
• EPS indicates the portion of company profits allocated to each outstanding share

How to calculate diluted earnings per share calculator?

To calculate diluted earnings per share (EPS), we use the following formula:

Diluted EPS = (Net Income - Preferred Dividends) / (Weighted Average Number of Shares Outstanding + Diluted Shares)

Let's break this formula down step-by-step using a simple example:

1. Net Income - This is the total net income earned by the company. Let's say it's $1,000,000.

2. Preferred Dividends - These are dividend payments to preferred shareholders that get priority. Let's say there were $20,000 in preferred dividends.

3. Weighted Average Number of Shares Outstanding - This is the number of common shares outstanding, weighted by time. Let's say it's 11,000 shares.

4. Diluted Shares - These are all the potentially dilutive securities like stock options, warrants, and convertible bonds. Let's say there were an additional 10,745 dilutive shares.

   • 545 stock options
   • 10,000 warrants
   • 200 convertible bonds

Plugging this into the diluted EPS formula:

1. Net Income = $1,000,000

2. Preferred Dividends = $20,000

3. Weighted Average Shares Outstanding = 11,000

4. Diluted Shares = 545 + 10,000 + 200 = 10,745

5. Diluted EPS = ($1,000,000 - $20,000) / (11,000 + 10,745) = ($980,000) / 21,745 = $45.07

So the diluted EPS for this example would be $45.07 per share. Comparing this to basic EPS gives you a sense of the potential dilution from all the additional securities.

I hope this explanation helps explain how to easily calculate diluted EPS! Let me know if you have any other questions.

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Do you use diluted EPS for PE ratio?

Diluted earnings per share (EPS) is an important metric to use when calculating the price-to-earnings (P/E) ratio. Here's why:

The P/E ratio is calculated by dividing the company's current share price by its earnings per share (EPS). There are two versions of EPS that can be used:

• Basic EPS - This only includes common shares outstanding and does not account for dilutive securities like stock options, warrants, convertible bonds etc.

• Diluted EPS - This includes all common shares outstanding plus the impact of dilutive securities. Since dilutive securities increase the number of shares, diluted EPS is always lower than basic EPS.

When calculating the P/E ratio, it is best practice to use diluted EPS rather than basic EPS. This gives a more conservative valuation ratio since the EPS number is lower.

For example:

• Company A has basic EPS of $2 and diluted EPS of $1.80
• At the current share price of $36, the P/E ratios would be:
  • Basic P/E = $36 / $2 = 18x
  • Diluted P/E = $36 / $1.80 = 20x

As you can see, the diluted P/E is higher due to the impact of dilutive securities on the EPS figure in the denominator.

So in summary, yes, you should use diluted EPS when calculating the price-to-earnings ratio to account for the potential dilution from outstanding stock options, warrants etc. This gives investors a more conservative and realistic valuation multiple.

Calculating Basic EPS

This section will provide a step-by-step overview of how to calculate basic EPS based on net income and shares outstanding.

Basic EPS Formula

The formula for basic EPS is:

(Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding

Find Net Income

Locate net income attributable to common shareholders on the income statement. This excludes any preferred dividends that must be paid.

Determine Common Shares Outstanding

Use the weighted average number of common shares outstanding during the period. This accounts for changes in shares over time.

Plug into Basic EPS Formula

Divide net income less preferred dividends by the weighted average number of common shares outstanding to calculate basic EPS.

Illustrating Basic EPS with an Example

For example, if net income is $10 million, preferred dividends are $1 million, and average common shares outstanding are 5 million, then basic EPS is ($10M - $1M) / 5M = $1.80.

Calculating Diluted EPS

This section explains how diluted EPS expands on basic EPS to account for dilutive securities like stock options that could potentially dilute future earnings.

Identifying Dilutive Securities

Dilutive securities like convertible bonds or employee stock options could potentially dilute EPS in the future if converted to common shares. These securities are not currently common stock but give their holders the right to convert them to common stock in the future.

Determining Dilutive vs. Anti-Dilutive Securities

Securities are considered dilutive if their conversion to common shares would decrease EPS. For example, if a company has convertible bonds outstanding that would dilute EPS upon conversion, they are dilutive securities.

Anti-dilutive securities are ignored in diluted EPS calculations because their inclusion would increase EPS. For instance, out-of-the-money stock options that have higher conversion prices than the current market value per share are anti-dilutive.

Diluted EPS Formula

The formula for calculating diluted EPS is:

(Net Income - Preferred Dividends) 
/ 
(Weighted Average Common Shares Outstanding + Dilutive Shares)

Calculate Dilutive Shares

To determine the number of dilutive shares to add, use either the treasury stock method or if-converted method depending on the security. This calculates how many additional common shares would be issued on conversion.

Plug into Diluted EPS Formula

Add the number of dilutive shares to the weighted average common shares outstanding. Plug this total shares number along with net income less preferred dividends into the diluted EPS formula above.

Comparing Basic and Diluted EPS with an Example

• Company A has net income of $10 million

• 5 million weighted average common shares outstanding

• 1 million employee stock options outstanding, dilutive using the treasury stock method

• Basic EPS = $10 million / 5 million shares = $2 per share

• Diluted EPS = ($10 million - $0) / (5 million shares + 1 million dilutive shares) = $1.82 per share

Diluted EPS is lower than basic EPS due to the dilutive effect of the additional shares from potentially exercised stock options.

Key Takeaways

Basic EPS Key Points

• Basic EPS only factors in common shares outstanding, making it easier to calculate
• However, it does not account for potentially dilutive securities like stock options and convertible bonds
• This means basic EPS may overstate earnings per share if these securities were converted to common shares

Diluted EPS Key Points

• Diluted EPS presents a more complete view by including potentially dilutive securities
• It involves more complex calculations and judgments on whether securities are dilutive
• Diluted EPS provides a conservative estimate of earnings per share if conversions/exercises occur

Using EPS Wisely

• EPS helps assess profitability, but has limitations like susceptibility to manipulation
• For a more complete analysis, EPS should be considered alongside other metrics
• Tracking basic and diluted EPS over time can provide insight into a company’s share structure

Related posts

• What is Earnings Before Interest and Taxes (EBIT)?
• How to Calculate Retained Earnings in QuickBooks
• Earnings Per Share (EPS) Basic vs Diluted
• Calculating EBIT in QuickBooks Made Easy