Diluted EPS
Also written Diluted earnings per share · Fully diluted EPS
Earnings per share recalculated as if every instrument that can convert into equity had already converted — the pessimistic, and usually the more honest, share count.
In plain language
Basic EPS divides profit by the shares that exist today. Diluted EPS divides it by the shares that will exist once every convertible instrument, warrant and employee stock option in issue has turned into equity.
The second number is smaller, and it is the one an analyst should use, because those instruments are already promised away. Ignoring them values a slice of the company that has effectively been sold to somebody else.
How it works
Every convertible instrument outstanding is treated as converted at the start of the period. The extra shares go into the denominator. Where conversion also removes a cost — a convertible debenture's interest, for instance — that saving is added back to the numerator.
If the result of a conversion would increase EPS, the instrument is anti-dilutive and is excluded. Dilution only ever moves EPS down.
The formula
Basic EPS = Profit attributable to equity holders ÷ Weighted average shares outstanding
Diluted EPS = (Profit + interest saved on conversion, net of tax)
÷ (Weighted average shares + all potential shares)
A worked example
A listed IT services company reports:
- Profit after tax: Rs 620 crore
- Shares outstanding: 50 crore
- Employee stock options outstanding: 4 crore, all exercisable
Basic EPS = 620 ÷ 50 = Rs 12.40
Diluted EPS = 620 ÷ 54 = Rs 11.48
That is a 7.4% haircut. Apply a P/E of 25 to each and you get a value of Rs 310 versus Rs 287 a share — a gap of Rs 23, or roughly Rs 1,150 crore of market value, turning entirely on which EPS was used.
Why NISM asks about it
Chapter 8 covers both EPS measures, and Chapter 10 uses EPS as the denominator of the P/E ratio. The examinable point is almost always which EPS belongs in a valuation, and the answer is the diluted one.
Common exam traps
- For a loss-making company, diluted EPS equals basic EPS. Adding shares to a loss would make the loss per share look smaller, which is anti-dilutive. The workbook tests this directly.
- Diluted EPS uses a weighted average share count, not the closing count — shares issued in March count for one month, not twelve.
- Options that are out of the money are still disclosed, but do not dilute.
Where this is taught
Free preparation for NISM Series XVRelated terms
- EBITDAProfit from running the business, measured before interest, tax, depreciation and amortisation — so before how the company is funded and how it accounts for its assets.
- Return on EquityProfit after tax as a percentage of shareholders' net worth — what the company earned on the money its owners have left in it.
- BuybackA company purchasing its own shares out of reserves and extinguishing them, reducing share capital and raising earnings per share for the shareholders who remain.