Question

In 100 words, or fewer, explain why investors should be more interested in the Diluted EPS number than the Basic EPS number.

Company X information for Diluted Shares calculations for period 201X: Earnings for Year 201X - $20 million Average Basic shares outstanding for Company X in 201X – 10 million Average Stock Price for year 201X - $6.00 Warrants to purchase common shares: - Warrants A to purchase 2 million shares ex @ $2.00 - Warrants B to purchase 3 million shares ex @ $5.00 for company 201X

Answer 1

Solution

Diluted EPS is a calculation used to gauge the quality of a company's earnings per share (EPS) if all convertible securities were exercised. Convertible securities are all outstanding convertible preferred shares, convertible debentures, stock options, and warrants. Unless a company has no additional potential shares outstanding—which is rare, the diluted EPS will always be lower than the simple or basic EPS.

The Formula for Diluted Earnings per Share

=Diluted EPS=Net Income−Preferred Dividends/WASO+CDS​

where:

WASO=Weighted Average Shares Outstanding

CDS=Conversion of dilutive securities

Dilutive Securities=In-the-money options, warrantsand other securities​

Diluted EPS considers what would happen if dilutive securities were exercised. Dilutive securities are securities that are not common stock but can be converted to common stock if the holder exercises that option. If converted, dilutive securities effectively increase the weighted number of shares outstanding, which decreases EPS.