Dilutive and Antidilutive Securities
When a company has issued securities that can be exchanged for common shares, converting the securities into common shares would potentially dilute the ownership stake of existing shareholders. When calculating earnings per share, companies must consider the potential dilution.
For securities that pay a dividend or periodic interest payment, the after-tax payments would be added back to earnings (since those payments would no longer be necessary if the securities were converted.) Then, the number of shares into which the securities are converted is added to the shares outstanding.
Diluted EPS = (Earnings + After tax payments on convertible securities)/(Shares outstanding plus shares issued on conversion)
In some cases, securities would be antidilutive, or increase earnings per share if they were assumed to be converted. Such securities are not included in the diluted EPS calculation, as it is intended to represent the maximum possible dilution.
For more information, see all articles on: Accounting, Financial Statement Analysis, Fundamental Analysis, Investing in Stocks 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)
