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Concept Version 6
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Calculating Diluted Earnings per Share

Diluted earnings per share (EPS) takes the basic EPS formula and accounts for the effect of dilutive shares on earnings.

Learning Objective

  • Explain why a company would calculate diluted earning per share for its stock


Key Points

    • Dilutive common shares from dilutive instruments, such as stock options or stock warrants, are added to the basic equation's denominator (weighted average number of common shares outstanding), which decreases the value of earnings per share.
    • Diluted earnings per share is the most conservative per share earnings number because the equation takes into account the largest number of common shares that could be outstanding.
    • Basic EPS, based on net income and reported on the face of the income statement, is followed by diluted earnings per share, also reported on the income statement.

Terms

  • dilutive

    Describing something that dilutes or causes dilution (reduces value).

  • weighted average

    An arithmetic mean of values biased according to agreed weightings.


Example

    • Sun Microsystems, Inc. has 3,417,000,000 weighted-average common shares outstanding with income available to common shareholders of USD 922,590,000 during a recent year. Stock warrants can be exercised for 1,000,000,000 common shares. Basic EPS = USD 922,590,000 / 3,417,000,000 = USD .27 per share. Diluted EPS = USD 922,590,000 / 3,417,000,000 + 1,000,000,000 = USD .20 per share.

Full Text

Diluted Earnings Per Share

Definition

Diluted Earnings Per Share (diluted EPS) is a company's earnings per share (EPS) calculated using fully diluted common shares outstanding (i.e. which includes the impact of instruments such as stock option grants and convertible bonds). Fully diluted common shares consider securities with features that will increase the number of common shares outstanding and reduce (dilute) earnings per share. Diluted EPS indicates a "worst case" scenario, one in which everyone who could have received stock did so without purchasing shares directly for the full market value.

Earnings per share shows the amount of income applicable to each share of common stock.

Diluted earnings per share includes shares of common stock from dilutive securities, such as convertible debt or stock options, in its calculation.

Calculation

The basic earnings per share formula involves taking the income available for common shareholders (net income minus preferred stock dividends), divided by the weighted average number of common shares outstanding. Dilutive common shares from dilutive instruments, such as stock options or stock warrants, are added to the basic equation's denominator (weighted average number of shares outstanding), which decreases the ending result of earnings per share. So, basic earnings per share tends to have a higher value than diluted earnings per share. Diluted earnings per share is the most conservative per share earnings number because the equation takes into account the largest number of common shares that could be outstanding.

Disclosure

Public companies calculate and disclose EPS for each major category on the face of the income statement. In other words, they make an EPS calculation for income from continuing operations, discontinued operations, extraordinary items, changes in accounting principle, and net income. Basic EPS, based on net income, is followed by diluted earnings per share and and both figures are reported on the income statement.

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