When it comes to earnings per share, there is more than meets the eye. Basic and diluted earnings per share are terms that may not be immediately familiar—but they are important to understand when looking at a company's financial performance. In this blog, we will explore the difference between basic and diluted earnings per share so you know how to properly evaluate these metrics.
What Are Earnings Per Share (EPS)?
Earnings per share (EPS) is a metric used to measure a company's financial performance. It expresses how much profit each share of stock earns for investors or shareholders. For example, a company with an eps of $2.00 has an earnings of 2 dollars for every share outstanding.
Basic earnings per share (EPS) is a calculation that divides the company's net income by the number of common shares outstanding during the period in question. This calculation assumes all available shares are used to calculate the EPS and does not factor in any potential dilution caused by stock options or convertible securities.
Understanding the Different Types of Equity Issuances that Affect Earnings Per Share (EPS):
Diluted earnings per share (diluted EPS) takes into account the potential dilution that could occur from stock options, convertible securities, warrants, and other equity instruments. These are securities that could eventually convert to common stock and would therefore increase the number of outstanding shares—thereby diluting the total earnings for each shareholder. Diluted EPS is calculated by dividing the company's net income by its total number of fully diluted shares for a given period. This is determined by adding any potential common shares that could be issued from stock options and convertible securities to the total count of common shares outstanding.
For example, if a company had 10 million common shares outstanding and then issued 500,000 options or convertible securities that could be converted into stock, its diluted EPS would take these potential additional shares into account. Assuming all securities were converted, the total would be 10.5 million shares, and diluted EPS would be calculated by dividing net income by 10.5 million instead of just 10 million.
Calculating both basic and diluted EPS gives investors an idea of how much their earnings per share could be affected by potential dilution—should certain equity instruments be exercised. Comparing these two figures can tell investors how much the company is potentially diluting its existing shareholders' earnings.
Calculating Basic EPS vs. Diluted EPS
The formula to calculate basic EPS is simple:
Basic EPS = (Net Income – Preferred Dividends) / Weighted Average Number of Common Shares Outstanding
For example, Apple Inc has a net income of $99.803 billion, and the weighted average number of common shares outstanding is 16.215963 billion.
Basic EPS = ($99.803 billion – $0) / 16.215963 billion
Basic EPS = 6.15
The formula to calculate diluted EPS is more complex:
Diluted EPS = (Net Income – Preferred Dividends) / Weighted Average Number of Diluted Shares Outstanding
For example, Apple Inc has a net income of $99.803 billion and the weighted average number of common shares outstanding diluted us is 16.325819 billion.
Diluted EPS = ($99.803 billion – $0) / 16.325819 billion
Diluted EPS = 6.11
In this example, Apple's basic EPS is higher than its diluted EPS because the additional 109.856 million shares were not factored into the calculation.
Automatic Basic and Diluted EPS
To get the basic eps of a company for a particular year, enter the following formula in a cell:
To get the diluted eps of a company for a particular year, enter the following formula in a cell:
=WISE("ticker", "eps diluted", "2019")
You can also get more metrics and build custom screeners like this in seconds:
Basic Earnings Per Share vs Diluted Earnings Per Share: Which one is better?
When it comes to evaluating the financial performance of a company, both basic and diluted earnings per share should be taken into account.
Basic EPS is usually used as it gives an accurate picture of the current earnings for each outstanding share. However, understanding the diluted EPS can give investors an idea of how their existing holdings may be affected by future dilution of shares due to stock options or convertible securities.
Analyzing both of these metrics will help investors make more informed decisions when evaluating a company's financial performance.
The Impact of Stock Splits on Basic and Diluted EPS
It's important to note that stock splits can affect both basic and diluted EPS calculations. Generally speaking, when a company splits its shares, the number of outstanding shares increases while the stock price decreases proportionally. This can have an impact on the basic EPS calculation as it is directly tied to the number of common shares outstanding during a given period. The effect on diluted EPS will depend on the situation, as it also takes into account potential dilution from stock options and convertible securities.
For example, if Apple Inc did a 5-for-1 stock split, it would increase the number of common shares outstanding from 16.215963 billion to 81.079815 billion and decrease the stock price by 1/5th. As a result, Apple's basic EPS would be reduced from 6.15 to 1.23 as more shares are now used in the calculation while its net income remains the same.
How to Use Earnings Per Share to Analyze a Stock's Performance
Understanding basic and diluted EPS can help investors evaluate a company's financial performance. Analyzing these two metrics in context with other key data points can give you a better idea of a stock's potential for growth or decline. For example, if the difference between basic and diluted EPS is small, it could indicate that the company is not issuing too many stock options or convertible securities that could potentially dilute the earnings per share in the future.
Comparing EPS to other key metrics such as revenue, cash flow, and return on investment can also give investors an idea of how efficiently a company is able to generate profits. For this, you can build a screener on Excel and Google Sheets that instantly provides you with all the data using Wisesheets.
Lastly, comparing a company's EPS over time can help you identify trends that could be indicative of future growth or decline.
In conclusion, basic and diluted earnings per share are important metrics to consider when evaluating a company's financial performance. Understanding the differences between these two measures can help investors make more informed decisions when analyzing a stock's potential for growth or decline. Comparing EPS with other key metrics such as revenue, cash flow, and return on investment can also provide valuable insight into a company's performance. Lastly, tracking the EPS over time can help identify potential trends that could be indicative of future growth or decline.
To your wise investments!