Companies in addition to shares already issued are also committed in issuing additional shares in future for various reasons. A company might have granted stock options to its executives who may execute it in future or the company would have borrowed money from financial institutions by which these lenders will have the right to convert the debt amount to shares.
There can be other reasons for which company may be required to issue shares or stocks in future.
Dividing net profit of the company by shares outstanding plus the number of shares that could be issued in future will give you diluted earnings per share (EPS).
Diluted earnings per share will take the calculation of basic EPS to one step further to determine net profit per shares that theoretically exist after all warrants, preferred stocks and / or convertible bonds have been exercised.
Mathematical formula to get diluted Earnings Per Share = Net profit of the company / shares outstanding plus un-exercised employees stock option plus convertible bonds plus warrants
Like basic EPS, diluted EPS is also required to be disclosed in the income statement along with basic EPS.
A publicly owned company in India or abroad reports both basic EPS and diluted EPS in its financial statement.
If a company has a simple capital structure and they don’t have to issue additional shares in future then both basic EPS and diluted EPS will be the same.
Also Read: What is Basic Earning Per Share
Example of Diluted EPS
Company X ltd has net profit of Rs. 200000 and 50000 shares outstanding at the end of the year. In addition to these outstanding shares, there are 3000 options that can be converted to shares in future at the rate of Rs. 10 each. Market price per share of X ltd is Rs. 20.
In order to calculate diluted EPS, we have to find out the denominator figure for outstanding shares. To exercise the option they need to pay Rs. 30000 i.e. 3000 multiplied by 10.
Now we need to divide the amount to be paid to exercise the option by the market price per share.
By dividing Rs.30000 with Rs. 20 we arrived at 1500 shares. To arrive at the number of shares that are to be issued extra we need to subtract 1,500 from the options figure of 3, 000. By doing that we arrived with a figure of 1, 500 which will be issued in future. Now we can calculate diluted EPS for company X.
Diluted Earnings per share for company X = Rs. 2, 00,000 / 50, 000 plus 1, 500 = Rs. 2, 00000/ 51500 = 3.89
Basic EPS for company X = Rs. 2, 00,000 / 50, 000 = 4
Diluted earnings per share will provide a more accurate estimate of the total earnings per share. By taking diluted EPS in determination of price to earnings ratio, stock will appear to be more expensive as PE ratio will become higher.There is no difference between a basic EPS and diluted EPS except the share outstanding figure in the denominator is adjusted in case of diluted EPS to include shares that might or will be issued in future by the company.