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Diluted Earnings per Share

One of the most commonly quoted financial measures of a company is the earnings per share or EPS. While this is useful, it doesn’t take into account all of the outstanding convertible securities (convertible preferred shares, convertible debentures, stock options and warrants) that could potentially dilute the earnings per share. The diluted earnings per share takes these convertibles into account to help determine the quality of a companies EPS. In almost every case the diluted earnings per share will be lower than the standard EPS measure.

Why is this important you might ask. Well, all of those outstanding convertible securities allow for the potential dilution of a companies earnings per share. All convertibles present the possibility that the number of outstanding shares could increase (in some cases dramatically). This dilution of earnings per share is a bad thing for investors as you probably know if you have ever witnessed a company missing its projected EPS on any given quarter.

Diluted earnings per share is a more conservative way of looking at a companies earnings and it presents a worst case scenario. Chances are that all of the people who are holding convertible securities are not going to exercise them and convert them to common shares all at once. However there is a good chance that all convertibles and options will be converted, especially if the company is doing well financially. A large difference between the EPS and diluted EPS can point to the possibility of significant share dilution and is something to bear in mind before investing in a company.

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