Q: I was reading an earnings report from one of my stocks and noticed two earnings-per-share figures: EPS and diluted EPS. What are diluted earnings, and which number should I pay attention to?
In most cases, EPS and diluted EPS will be slightly different, with diluted EPS being the lower of the two figures. And the language can vary slightly among companies. For example, you may read that a company earned $1 per share or $0.94 on a "fully diluted" basis.
Here's the difference: Standard earnings per share (EPS) is based on a company's outstanding shares -- or, more specifically, on its weighted average outstanding shares during the reporting period. In other words, if a company earned $1 million and had 1 million outstanding shares, its EPS would be $1.
On the other hand, diluted EPS is based on the number of shares a company could eventually have outstanding. This not only includes the current outstanding shares but any convertible preferred stock, outstanding stock options, warrants, and other instruments that could result in future common shares being issued.
As a simplified example, let's say that a company earned $1 million and had 1 million outstanding shares. It also has convertible preferred stock and outstanding stock options that could result in an additional 100,000 shares being issued. So, the earnings calculation would be based on 1.1 million shares, making the diluted EPS about $0.91.
Both numbers are important, but I'd pay closer attention to diluted EPS when assessing a stock's performance, as it gives a more accurate picture of what a company's earnings could be if all potentially dilutive securities were to be exercised.