Earnings Per Share (EPS) vs. Diluted EPS: What’s the Difference?

Earnings Per Share (EPS) vs. Diluted EPS: An Overview

Earnings per share (EPS) and diluted EPS are profitability measures used in the fundamental analysis of companies. EPS takes a company’s common shares into account. Diluted EPS takes all convertible securities into account, such as convertible bonds or convertible preferred stock which are changed into equity or common stock. 

Key Takeaways

• Earnings per share (EPS) take only common shares into account while diluted EPS includes convertible securities, employee stock options, and secondary offerings.
• Dilutive effects occur when the number of shares increases such as through a new issue.
• There’s generally the risk of EPS dilution if a company has convertible securities or employee stock options.
• Many analysts prefer diluted EPS as a more comprehensive figure because of this risk.
• Diluted EPS is always less than its basic EPS.

Earnings Per Share (EPS)

EPS measures the amount of a company’s profit on a per-share basis. Basic EPS doesn’t account for the dilutive effects that convertible securities have on EPS. Dilutive effects occur when the number of shares increases such as through a new share issue. It increases the number of shares outstanding when a company issues more shares to investors and this decreases the company’s EPS. This can ultimately decrease the stock price.

Calculate a company’s basic EPS by taking a company’s net income and subtracting any preferred dividends. Then divide the result by the weighted average number of common shares outstanding. The weighted average is a measurement that investors use to monitor the cost basis on shares accumulated over a period of years.

Diluted EPS

Diluted EPS is a metric used in fundamental analysis to gauge a company’s quality of EPS assuming all convertible securities have been exercised. Convertible securities include all outstanding convertible preferred shares, convertible debt, equity options which are mainly employer-based options, and warrants.

You can calculate diluted EPS by taking a company’s net income and subtracting any preferred dividends. Then divide the result by the sum of the weighted average number of shares outstanding and dilutive shares such as convertible preferred shares, options, warrants, and other dilutive securities.

Example of Earnings Per Share (EPS) vs. Diluted EPS

Assume Company ABC had $50 million in net income over the past year but it didn’t pay any dividends. It has 15 million common shares outstanding. The resulting EPS for Company ABC is:

Now assume that ABC grants employee stock options and convertible preferred shares in addition to its 15 million shares outstanding. The employee options could be converted to 1 million additional common shares and the convertible preferred shares could be converted to 3 million common shares. The resulting diluted EPS for Company ABC is:

The diluted EPS is generally going to be less than its basic EPS if a company has dilutive securities.

Is EPS or Diluted EPS Better?

Earnings per share (EPS) is an important metric for understanding a firm’s profitability. Many companies have additional shares in reserve in the form of equity compensation, employee stock options, or convertible securities so diluted EPS provides a more comprehensive view of potential per-share profitability.

Why Is Diluted EPS Important?

Diluted EPS accounts for shares that aren’t yet outstanding but could be in the future. These can arise from convertible securities that are turned into common stock or via the exercising of employee stock options.

Actions such as these will effectively increase the number of shares outstanding so they’ll also dilute the firm’s overall profits when it’s evaluated on a per-share basis. Knowing the fully-diluted EPS is therefore important for understanding how current shareholders may be impacted down the road.

What Does a Higher EPS Indicate?

A higher EPS is favorable because it represents increased profitability to the firm. You must check how many shares are outstanding and consider both historical EPS and forward projections in addition to current results, however.

The Bottom Line

The EPS measurement is focused solely on a company’s common shares. Diluted EPS extends beyond this to consider convertible bonds that are changed into common stock or equity, secondary offerings, and employee stock options. Diluted EPS uses a larger basket and therefore tends to be more comprehensive and revealing.

Disclosure: Investopedia does not provide investment advice. Investors should consider their risk tolerance and investment objectives before making investment decisions.