What is diluted earnings per share (EPS)?
Companies that have both stock and other securities, which can be converted into common stock, outstanding are considered to have a complex capital structure. Converting these other securities into shares would dilute (reduce) the percentage held by current shareholders. For example, investor A holds 100 shares of a company with 1,000 shares outstanding, which represents a 10% ownership interest. This same company has issued stock options for 250 shares to employees. If these options were exercised, investor A would then hold 100 shares out of 1,250, or an 8% interest. This represents a substantial dilution of investor A’s interest. Of course, if the employees were required to pay for their shares, the company would have more cash. Analysis of the company’s financial statements and notes would reveal the magnitude of potential dilution to the prospective investor.
Diluted earnings per share is computed by estimating the impact of potentially dilutive securities after determining how many shares would be outstanding if they were exercised. The resulting number therefore does not reflect a true historical number. Instead, it provides an estimate of the dilutive impact of these securities should they be exercised in the future.
For more information, see all articles on: Accounting, Financial Statement Analysis, Fundamental Analysis See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
