Definition
Basic Earnings Per Share (EPS) is a financial measure calculated by dividing net income less preferred dividend by the average outstanding shares. On the other hand, Diluted EPS considers what would happen if all convertible securities (like options, convertible bonds, etc.) were exercised, thereby increasing the total number of shares and demonstrating less earnings per share. Consequently, Diluted EPS is generally lower than Basic EPS and presents a more conservative view of a company’s performance.
Key Takeaways
- Basic EPS is a measure of a company’s earnings per share based simply on the existing number of shares during the period. It calculates the net income that each outstanding share of common stock could theoretically claim.
- Diluted EPS, on the other hand, takes into account all shares that could potentially be generated from existing securities such as stock options, convertible bonds, convertible preferred shares and others. It provides a more conservative measure of a company’s profitability.
- A lower Diluted EPS in comparison to Basic EPS indicates the potential dilution of share value if all convertible securities were exercised. This can be useful for investors to understand the worst-case profitability scenario for their holdings.
Importance
Basic Earnings Per Share (EPS) and Diluted EPS are both crucial metrics in financial analysis, and their comparison provides essential insights into a company’s financial health.
Basic EPS is calculated by dividing net income by the outstanding shares, rendering a basic view of a company’s profitability on a per-share basis.
On the other hand, Diluted EPS accounts for all potential dilution effects—like stock options, convertible securities, etc.—and depicts a more conservative viewpoint on the company’s profitability.
The comparison thus reflects aspects like potential dilutive risk and delves a layer deeper into understanding a company’s financial performance and future prospects.
This is especially important for potential investors and stakeholders as the comparison provides a more thorough understanding of the company’s earnings quality and stability.
Explanation
Basic Earnings Per Share (EPS) and Diluted EPS primarily serve as performance indicators, helping to reveal a company’s profitability from the perspective of stockholder equity. Basic EPS is a straightforward measure that divides the company’s raw profit or net income by the number of outstanding common shares during a specific period.
This figure is used by potential investors, analysts, and the company’s management to gauge how much profit is generated per share of stock, hence indicating the company’s efficiency at generating shareholder wealth. On the other hand, Diluted EPS is a more conservative estimate that assumes all convertibles such as options, warrants, convertible bonds, or other potential sources of additional shares are exercised and shows what earnings per share would be if all these sources were to dilute the total number of shares.
It provides shareholders and prospective investors more comprehensive information about the company’s performance and potential future earnings, as it accounts for the dilutive effect of these potential shares. When comparing the two, if the Diluted EPS is much lower than the Basic EPS, it may be a cautionary sign for prospective investors as it indicates a high level of potential dilution in the future.
Examples of Basic EPS vs Diluted EPS
Basic EPS vs. Diluted EPS in Alphabet Inc: Alphabet Inc., the parent company of Google, reported basic EPS of $61 and diluted EPS of $61 for the fiscal year end December 31,
This indicates, there were no convertible securities or stock options that could potentially dilute the earnings per share.Basic EPS vs. Diluted EPS in Walmart Inc: For the fiscal year ended January 31, 2021, Walmart Inc. reported a basic EPS of $75, whereas the diluted EPS was $
Similar to Alphabet Inc., this means that there were no potential dilutive securities or stock options that could decrease the earnings per share.Basic EPS vs. Diluted EPS in Tesla Inc: In contrast to the previous examples, Tesla Inc., for the fiscal year ended 2020, reported a higher basic EPS of $62 than its diluted EPS of $
This indicates the presence of securities like stock options, convertible debentures etc. that, when exercised, will increase the number of outstanding shares and subsequently lower the EPS. This illustrates the concept of dilution, where existing shareholders’ stake in the company is diminished.
FAQs about Basic EPS vs Diluted EPS
What is Basic EPS?
Basic Earnings Per Share (EPS) is a measure of the net income of a company allocated to each outstanding share of common stock. It is calculated by dividing net income by the average number of outstanding shares during a particular accounting period.
What is Diluted EPS?
Diluted EPS considers what would happen if all convertible securities were exercised. It takes into account the potential dilution that could occur if all convertible securities such as options, warrants, convertible bonds, and convertible preferred stock were converted into common stock.
What is the difference between Basic EPS and Diluted EPS?
The primary difference between the two lies in the number of shares used in their calculation. Basic EPS does not incorporate potential dilution that can lower earnings per share, while Diluted EPS does. This is why Diluted EPS is often lower than the Basic EPS.
Which one is more significant for investors?
Both Basic and Diluted EPS are important for investors. Basic EPS provides a clear picture of the company’s earnings from its current stock, while Diluted EPS offers an overview of the company’s earnings given all conversions. If the Diluted EPS is drastically lower than the Basic EPS, it could be a warning sign that significant dilution may occur in the future.
Related Entrepreneurship Terms
- Earnings Per Share (EPS)
- Dilution
- Convertible Securities
- Share Dilution
- Stock Options
Sources for More Information
- Investopedia: A comprehensive online financial dictionary featuring thousands of terms and their definitions.
- The Balance: Offers comprehensive and easy-to-understand articles and guides on a variety of financial concepts, including basic and diluted EPS.
- Corporate Finance Institute: Provides in-depth financial knowledge including financial analysis, modeling, valuation etc.
- Accounting Coach: Website dedicated to helping learn and understand accounting concepts.
