 Personal Finance PowerPoint Presentation Diluted Earnings Per Share Diluted EPS Prepare to get financially fit by practicing personal finance Most of this information comes from Investopedia Diluted Earnings Per Share Diluted EPS Which you can find online Take a look at the references, resources, continue your research from there This by Will Kenton updated April 17th, 2021 In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools Keeping in mind the two major categories of investment That being the fixed income, typically the bonds And then the equity, typically the common stock Now we're asking what is Diluted Earnings Per Share Diluted EPS Diluted Earnings Per Share is a calculation used to gauge the quality of a company's earnings per share EPS If all convertible securities were exercised So note here, we're talking about in essence the stock side of things When we're doing an analysis of the Diluted Earnings Per Share Remembering that the stock represents ownership in a company A company being a separate legal entity that has its ownership broken out into equal units Those being then the stocks We're usually talking about publicly traded companies Companies that are trading on an exchange Which is making it able for us to have access as investors to the stocks Then we're trying to value the valuation of those stocks And we're going to be doing so by thinking about their performance numbers That's going to be typically their income statement numbers The bottom line being the net income as compared to the ownership of the stock Which is broken out into those unit ownership of stocks We can think about the earnings per share, the earnings per unit of stock Now it gets a little bit confusing in that we could have some securities out there Some types of investment vehicles out there that have a convertible component to them So if there was some kind of exercise of that conversion We could have then more stocks out there than currently are out there If there was no conversion happening So we might want to then calculate not just the earnings per share based on the current number of shares outstanding But also the diluted earnings per share Assuming that all of these instruments that could be converted were converted What would the earnings per share be there? In that case, that being the diluted earnings per share So convertible securities are all outstanding convertible preferred shares Convertible debentures, stock options and warrants So we've talked about these a bit in prior presentations These are those kind of securities that have that convertible component Which could be resulting in more common shares out there So the diluted earnings per share will usually be lower than the simple or basic earnings per share But in the rare case that there are anti-dilutive securities it may be higher So most of the time we're talking about securities that can have an exercise option Were to exercise then you would have more shares that would be outstanding But you could have some rare cases in which it would go the other way Having less shares than outstanding So in this case only the basic earnings per share is reported in the financial statements So formula for diluted earnings per share So the diluted earnings per share is the net income You'll remember that's basically on the income statement Bottom line of the income statement, the performance statement Minus the preferred dividends Because the preferred dividends are an equity interest that needs to be paid first Before you're paying out to the common stocks We take that out divided by the WASO plus the CDs The WASO is the weighted average shares outstanding So you're taking a look at the shares that are outstanding Noting that usually when you're looking at the number of shares outstanding You could take the number of shares outstanding as of a point in time Which is the time of the calculation So if you're doing this for a year, for example The net income represents earnings over a year You need the whole time frame for the earnings Whereas the number of shares is kind of a balance sheet item as of a point in time The easiest number to take would be at the end Or when you're calculating the calculation at the end of the year But you might use kind of a weighted average shares outstanding To get an idea of the number of shares approximated through the year And that would be useful if there were changes to the number of shares that were outstanding And then we got the CDS which is the conversion of diluted securities So here's the thing that is that diluting factor Taking into consideration those securities that if exercised Would result in more of the stocks out there increasing the denominator So what diluted earnings per share diluted EPS can tell you Diluted earnings per share considers what would happen if diluted securities were exercised Diluted securities are securities that are not common stock But can be converted to common stock if the holder exercises that option So if convertible diluted securities effectively increase the weighted number of shares outstanding Which decreases the earnings per share So clearly if they're exercised if we assume that all those are exercised The numerator then or the denominator is going up Which is going to bring the whole thing down And that's why it's the diluted earnings per share Because it will typically be less than the normal earnings per share So if converted diluted securities effectively increase the weighted number of shares outstanding Which decreases the earnings per share Earnings per share significance Earnings per share the value of earnings per share of outstanding common stock Is a very important measure to assess a company's financial health When reporting financial results revenue and earnings per share are the two most commonly assessed metrics Earnings per share is reported on a company's income statement And only public companies are required to report it So if they're publicly traded companies then you're going to see that Earnings per share calculation and it's going to be an important metric So in their earnings in their earnings reports Companies report both primary and diluted earnings per share But the focus is generally on the more conservative diluted earnings per share Dilutive earnings per share is considered a conservative metric Because it indicates a worst case scenario in the terms of earnings per share In other words they like to have the earnings per share being higher the higher the number the better Because that's more earnings per unit of share But we want to take the conservative measure often times And therefore we might put more focus on the dilutive earnings per share So it is likely that everyone holding options warrants convertible preferred stocks etc Would convert their shares simultaneously In other words if the circumstances became favorable For those securities to be converted Those conversions would probably all happen at the same time They would all be triggered at the same time So you might say well this is kind of overdoing it Because you're going to have some of those securities that people will choose to convert not And it will depend on the investor But it's not so much dependent upon the investor It's dependent upon the circumstances in the market And if you hit to a point where it's becoming more advantageous for the conversions to take place You would think that pretty much all the conversions would just bang boom happen And be converted and then you'd have those more shares outstanding However if things go well there is a good chance that all options and convertibles will be converted into common stocks Meaning what is a favorable condition to convert the companies doing good And therefore the value of the shares are going up And therefore the conversion feature looks very enticing to exercise To make a conversion to the common stock A large difference between a company's basic earnings per share and diluted earnings per share Can indicate high potential dilution for the company's shares An unappealing attribute according to most analysts and investors For example company A has 10 billion dollars outstanding shares There is a 10 cent difference between the basic earnings per share and diluted earnings per share While 10 cent seeds insignificant equates to 900 million in value not available to investors For example of diluted earnings per share Convertible preferred stock, stock options and convertible bonds are common types of dilutive securities Those are the ones if which exercise would increase the number of shares outstanding So convertible preferred stock is a preferred share that can be converted to a common share at any time Stock options a common employee benefit grant the buyer the right to purchase common stock at a set price at a set time Convertible bonds are similar to convertible preferred stock As they are converted to common shares at the prices and times specified in their contracts All of these securities if exercised would increase the number of shares outstanding and decrease earnings per share