Basic EPS vs Diluted EPS

When investors talk about earnings per share (EPS), they generally refer to basic or diluted EPS. Basic EPS is calculated by dividing a company’s net income after taxes by its weighted average shares outstanding during a specific period. On the other hand, diluted EPS accounts for all potential dilution that could occur from stock-based compensation, warrants, convertible securities, and other dilutive instruments.

Comparing basic EPS and diluted EPS

Basic and diluted earnings per shares (EPS) are similar, but different concepts. Basic EPS is calculated by dividing a company’s income or profit by a certain number of shares outstanding. Diluted EPS takes into account all potential dilution that would occur if convertible securities were exercised or options were converted to stocks.

Generally, diluted earnings per share should be used in valuing a company if you expect there will be significant dilution from employee stock options or other potential dilutive actions. Otherwise, basic earnings per share provide enough information about future cash flows.

A hypothetical example using basic EPS versus diluted EPS illustrates how each number differs when it comes to calculating the value for an investor. To keep things simple, let’s say that someone owns one share in Company X which has a net income of Rs. 1 crore in year 1—and no additional debt or equity financing was required during its first year of operations.

Assume a total of 100 shares outstanding and a price per share of Rs. 10. For simplicity, let’s ignore the effects of taxes and dividends. In year 2, stock options are awarded to 50 employees with an exercise price of Rs. 5 per share. Additionally, 10 employee stock purchases were priced at Rs. 7 per share to reduce risk through diversification among all employees. These actions resulted in all 110 potential shares being diluted by 5% while net income increased by 10%. If you divide earnings by basic EPS instead of diluted EPS, you get Rs.0.91 instead of Rs.0.95 per share.

Using both types of earnings per share is valuable to an investor because they offer two different views of a company’s value based on the forecast between now and sometime in the future.

In short, diluted earnings per share (EPS) is simply a company’s net income divided by its shares outstanding. Basic EPS takes into account only those shares that are available for trading, which may be greater than a company’s total number of outstanding shares.

Calculation of Basic EPS vs Diluted EPS

A stock’s earnings per share (EPS) is when you divide a company’s net income by its weighted average number of shares outstanding during a given period.

Basic earnings per share is a company’s income divided by its total number of outstanding shares. It’s a useful metric when looking at a company’s profitability over time as it accounts for one-time items and ignores what investors call extraordinary items.

Basic EPS is calculated as follows: [Net Income / Total Shares Outstanding] × 100 = Basic Earnings Per Share.

Basic EPS tells you how much money a company made on average from each share that was outstanding during a given period. For example, if Company XYZ had a net income of Rs. 100 crore last year and 10 crore shares outstanding during that time. Then, it would have basic earnings per share (EPS) of Rs. 10 (Rs.100 crore/10 crore).

Generally speaking, diluted earnings per share uses the same number of shares outstanding as basic but adds any potential additional shares that might be issued through convertible bonds or preferred stock options.

Let's say that a company has 100 crore fully-diluted shares outstanding with 4 crores in warrants in its treasury giving them another 4 crores in potential shares waiting to be sold. They make a profit of Rs. 100 crore. Divided by 100 crore shares, you get earnings per share of Rs. 1 per share. But, since you added those 4 crore potential shares before taking into account any type of actual dilution, your total diluted earnings per share calculation ends up being Rs. 1.04 per share – not Rs. 1 as reported under basic EPS.

What are the key differences between the two EPS?

Basic earnings per share, or Basic EPS, doesn’t take into account any shares that have been added to existing shares through a stock split. Basic EPS is calculated by dividing net income by the total number of common shares outstanding. The profit number used in basic EPS can be either before or after taxes depending on your company’s reporting policy.

Diluted EPS takes basic EPS one step further by also considering potential dilution. When you issue more common shares, each existing share’s ownership percentage decreases slightly because more people own a piece of it. This decrease in ownership usually isn’t considered enough to lower your profits per share from one year to another. Therefore, basic EPS considers only unchanged shares.

One of the key differences between basic and diluted earnings per share is that when you account for dilution through, say, employee stock options or convertible securities, they are added to total shares outstanding when calculating diluted EPS. If more shares are outstanding in a company’s float, then its diluted earnings per share will be lower than its basic earnings per share.

Final Words

With both methods, investors need to understand which one will be reported on public financial statements and why it matters in certain situations. Knowing about basic EPS vs diluted EPS is important as it can help you make an informed decision when investing in your next opportunity.