Diluted Earnings Per Share Explained

Diluted Earnings Per Share Explained

The aim of this article is to put forth the details related to the calculation of diluted earnings per share, for any market-listed company.
Every business cannot be profitable and every businessman cannot be a legend. Though this statement has not been made to discourage you, it is undeniably a fact that you cannot ignore. Just go through the performance of companies listed on the stock market and you will find that very few of them are actually capable of posting exceptional profits. Identifying these highly successful companies is of prime importance for retail, as well as individual investors. The diluted earnings per share (EPS) is one parameter which needs to be studied carefully, before you take any stock trading decision.

What is EPS?

Profit maximization is the prime aim of any business firm. Whether the firm is able to achieve its objectives is known from the earnings it generates per share. To calculate EPS, we must be aware of the net profit made by the firm. This can be calculated by subtracting the expenses, taxes, and depreciation from the total turnover of the company. Every profitable company pays dividends to its shareholders and these are paid on a per share basis. To calculate the EPS using a formula, you need to subtract the dividends paid, from the net profit. Then divide it by the total shareholder equity, to get your final answer.

Earnings Per Share (EPS) = (Net income - Dividends paid)/(Average outstanding shares)

The more the earnings per share of a company, the more will be its profitability. You can compare the earnings of a particular company to others in the same sector and choose the finest one from among them, that can provide you with the best stock appreciation in terms of price. Apart from the earnings per share, you also need to consider other factors such as total turnover, industry positions of the firms, and their market share.

Meaning of Diluted Earnings Per Share

When you calculate diluted EPS, you have to include warrants or convertible shares in the number of the total outstanding shares. So, there will be a slight modification in the formula. The number of outstanding shares will change, once the management has exercised all the preferred stock bonds, convertible bonds, stock options, as well as warrants. Since every company has warrants that are not exercised, diluted EPS is always lower than the undiluted one.

Earnings per share is basically of three types - trailing EPS, forward EPS, and current EPS. While trailing EPS is dependent on the previous years' numbers, the current year EPS numbers are the projections of the present financial year. On the other hand, forward EPS is calculated to estimate the earnings growth of the company in the upcoming future. Stock market analysts use diluted earnings per share for research and assigning the right price targets to stocks, by considering the fundamental performance of companies.

Use this information to distinguish profitable companies, from the loss-making one, and locate quality stock.