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.
Check yourself
1.Which statement about diluted EPS is correct according to the workbook?
- a)Diluted EPS assumes that all warrants, ESOPs and convertibles are converted, whether or not they are in the money
- b)For a loss-making company, diluted EPS and basic EPS are one and the same
- c)Diluted EPS divides the unadjusted net profit by the basic weighted average share count
- d)Only companies with outstanding convertible debentures disclose diluted EPS
Show the answer
Answer: (b) For a loss-making company, diluted EPS and basic EPS are one and the same
The workbook states it directly: "For loss making companies, diluted EPS and basic EPS are one and the same."
Why the others are wrong:
- A: diluted EPS "assumes that in the money warrants, ESOPs and convertible instruments are converted into equity". The qualifier is in the money, meaning instruments that could be converted "without payment of full consideration".
- C: both halves are wrong. The profit is adjusted, because "the potential impact of such exercise/conversion on the profit and loss account are also factored", and the denominator is the diluted share count: "Diluted EPS is then calculated by dividing the adjusted net profit number by the diluted share count."
- D: "In terms of EPS, a company discloses Basic EPS and Diluted EPS". Both are disclosed, not only when convertibles exist.
For reference, basic EPS divides net profit attributable to equity shareholders by the weighted average number of shares outstanding, weighted by the time each share was outstanding.
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.
- Earnings yieldEarnings per share divided by the current market price — the reciprocal of the P/E ratio, expressed as a percentage so that equity can be set directly against a bond yield.
- Other Comprehensive IncomeGains and losses that Ind AS requires or permits to bypass the profit and loss account — they change shareholders' equity and never touch earnings per share.
- Stock splitA corporate action that cuts the face value of a share in a defined ratio and multiplies the number of shares to match — more shares, a lower price, and not one rupee of new value.
- Dividend Payout RatioDividend per share divided by earnings per share — the share of profit a company hands to shareholders rather than ploughing back into the business.
- Adjusted profit after taxReported profit after tax with one-off, non-recurring items and their tax effect stripped out, so one year can be compared fairly with another.
- Trailing earningsEarnings measured over the most recent period up to today, calculated on a rolling basis — most often as Trailing Twelve Months, distinct from historical or forward earnings.
- Non-controlling (minority) interestThe share of a subsidiary's equity and profits belonging to shareholders other than the parent — a line that appears only in consolidated financial statements.