Differences between basic EPS and diluted EPS

Basic EPS is a good calculation method for smaller companies whereas bigger corporations need to use diluted earnings per share technique for precise calculation

Key Takeaways

• Both basic EPS and diluted EPS are important metrics for companies to find an accurate PE ratio.
• Basic EPS takes into account only the common shares in the calculation process whereas diluted EPF takes both common shares along with convertible securities of any company.
• If a company has a complex capital structure then it is better to use diluted EPS for a more precise result and in case the capital structure of your company is simple then you can easily use the basic EPS.
• The value of basic EPS is usually higher than the diluted EPS but the value of diluted EPS can never become higher than basic EPS. Nevertheless, their values can sometimes match each other.

Summary in brief

• What is basic EPS or basic earnings per share?
• What is diluted earnings per share or diluted EPS?
• How does EPS diluted vs basic influence the decision of the investors?
• More about basic EPS and its calculation method
• More about diluted EPS and its calculation method
• Fundamental difference between basic EPS and diluted EPS
• What about the practical application of basic eps and diluted eps?
• A list of stocks with their 5 years of historical EPS growth
• Final words
• Frequently Asked Questions

Both EPS basic and diluted earnings per share or diluted EPS are considered the primary metrics used to assess any established company or business’ financial performance and its profitability. The company's remaining equity shares are taken into consideration when calculating basic earnings per share (EPS). 

At the same time, when calculating diluted earnings per share, convertible securities like loans, warrants, etc. are also taken into account. The difference between EPS and diluted EPS is an extremely crucial factor for investors because both of these calculations can help in the company's fundamental analysis.

What is basic EPS or basic earnings per share?

The basic EPS or earnings per share is an indicator of a company's ability to generate money on the basis of its share. Anyone can evaluate a company’s profitability with the help of basic EPS and it also showcases the fair price per share of the company.

In order to find out the basic EPS of a company you need to divide the net income or loss for the present fiscal year by the cumulative average number of outstanding common shares. In this case, when calculating the company’s profit you will have to consider the expenditure of the company and its earnings. Additionally, preference dividends, debenture interest, tax expenditures, etc. are taken into account while calculating the company’s net income.

What is diluted earnings per share or diluted EPS?

With the help of diluted EPS or diluted earnings per share, you can evaluate any company’s earnings per share while making use of the diluted outstanding stocks. The term diluted outstanding stocks refers to the total number of shares outstanding after all sources of conversion have been exercised, such as convertible bonds, warrants, etc.

This idea states that if the company assets are exchanged wholly or partially in part, the number of shares outstanding will rise at any moment, lowering the firm's earnings per share.

How does eps diluted vs basic influence the decision of the investors?

As an investor, you can certainly choose or pick out shares that you can invest in using both the basic EPS and diluted EPS. You can also put more emphasis on diluted EPS, due to the fact that it can show you the company's profitability after dilution.

Additionally, earnings per share basic vs diluted is another crucial factor you should watch out for as an investor. If you find out that there is a noticeable difference between the two (after researching the company you want to invest in), dilution's negative effects are to blame. Investors should take into account basic eps vs diluted eps and act appropriately if the two of these parameters are the same or closely related.

More about basic EPS and its calculation method

In order to measure the basic EPS of a company all the payable dividends need to be deducted and more importantly, the net income of the shareholders also doesn’t have dividends included in them for EPS calculation. 

There are two different types of preferred shares, namely, cumulative shares and non-cumulative shares. In the case of cumulative shares, the investor’s or shareholder’s obligations are always subtracted from them even if they are paid yet. For non-cumulative shares, it is the exact opposite. If the dividend for shares has been declared then only it can be deducted from non-cumulative shares.

To get the basic EPS we compute the weighted average number of outstanding common shares before calculating the total number of common shares. Rather than using a year-end figure, a weighted average figure is employed since the total number of common shares fluctuates a lot over the year.

Basic EPS = (Net Income – Preferred Dividend)/ Outstanding Common Shares

Let us understand the basic EPS with an example. Suppose a company named MNC has had a revenue of Rs. 100 crore and the number of its outstanding shares are 1 crore. Therefore, the EPS of the company would be Rs. 100 on each share. 

However, the formula of basic EPS has an issue, which is, it only considers the outstanding shares. As an investor, you need to know that other possible sources of stock dilution may exist for a corporation. For example, a business may have marketed warrants that, if exercised, would reduce equity.

If redeemed, convertible debentures that a business may have additionally issued might have increased the number of outstanding shares. When computing diluted EPS, all of these possible sources of stock dilution are taken into consideration. As a result, diluted EPS provides a precise representation of a company's real earnings per share.

More about diluted EPS and its calculation method

As investors or shareholders, we must always take into account and recognise all possible ordinary shares when determining diluted EPS. Any financial product that can eventually result in one or more common shares is known as a prospective ordinary share. A potentially dilutive share is one that lowers EPS as a result of an increase in the number of shares, which raises the denominator value. 

Diluted EPS = (Net Income + Convertible Preferred Dividend + Debt Interest) / All convertible securities plus common shares.

Bonds with a conversion option that yield common shares, convertible preferred shares that can be turned into common shares and warrants along with stock options that allow the holder to purchase common shares at a certain price are all part of the ordinary shares.

The fundamental difference between basic EPS and diluted EPS

There is a clear difference between diluted eps vs basic eps due to the following reasons:

• The number of shares is increased in diluted EPS and that is why the earnings of diluted EPS are comparatively less than that of basic EPS. Even though the net earnings in both cases remain the same.
• With the help of basic EPS companies can evaluate the revenue earned by a company on every share but diluted EPS helps in understanding the quality of the company’s quality of EPS.
• Diluted EPS accounts for potential dilution resulting from convertible securities, options, warrants, and other instruments. Basic EPS, in contrast, does not take it into account while the calculation is in process.
• If a company has a simple capital structure then it will be able to employ the basic EPS but if the company has a complex capital structure then it should make use of the diluted EPS.
• The basic EPS is a very simple method through which investors and analysts can measure the profitability of a company whereas diluted EPS is a very complex procedure.
• Although basic EPS majorly helps in understanding the current monetary position of a company, however, experts have doubts about the overall accuracy of this method. The more intricate but accurate way of calculating a company's financial status is undoubtedly the diluted EPS method.
• By subtracting the preference dividend from net income and dividing the result by the total number of outstanding equity shares, you will be able to compute basic earnings per share or basic EPS. On the other hand, diluted EPS needs to be determined by adding dividends, net income, debt interest, etc. and then dividing this amount by the number of outstanding shares along with all convertible instruments of the business.

What about the practical application of basic eps and diluted eps?

When determining the P/E ratio, which is employed for a company’s valuation, EPS becomes very crucial. Therefore, it is extremely essential to calculate EPS accurately. Basic earnings per share or basic EPS is undoubtedly a reliable indicator of a company's current profitability; however, diluted EPS is more practical and scientific since it accounts for prospective dilution and prevents misrepresenting the books to shareholders.

The diluted EPS accounts for the possible effects of the common share price, partially convertible debt, completely convertible debt, stock options, and preference shares, whereas the basic EPS assumes just issued and outstanding shares of a corporation.

The diluted EPS is more responsible from a practical standpoint since it considers the possible effects of the dilution of convertible shares and instruments. All of this results in an extremely accurate EPS number, which in turn results in a more effective P/E ratio.

A list of stocks with their 5 years of historical EPS growth

(Price date as per December 26, 2022)

Final words

While purchasing the stocks of a company the aim of each and every investor is to increase the overall value of their assets and at the same time, they also receive dividends from the company. However, as an investor, you need to remember that the share price of a company and its dividend payments are directly related to the EPS of the company. EPS is an important tool for retail investors who are willing to invest strategically.

Knowing or understanding the difference between basic eps and diluted eps is extremely important in order to undertake a wise investment opportunity. More importantly, all retail investors should know about which kind of EPS evaluation technique is used and mentioned by a particular company and what are the effects of the evaluation technique before investing in the same.