Earnings Per Share: Diluted - Lesson 1 - YouTube

Okay, now let's talk about what we call "Diluted Earnings per Share".

Now this is diluted because it's a complex capital structure.

Remember over here we had basic, basic said, "Assume there's nothing potentially diluted.

Here, in a complex capital structure, it's anyone who could convert, we assume they do

so.

It doesn't mean they actually did but it says, "Anyone who could convert and it's economically

advantageous."

What does economically advantageous mean?

It means that it is dilutive and the word dilutive is very important.

Dilutive means that everyone's earnings per share goes down.

If you gave money and earnings per share went up, that's antidilutive.

We don't assume you're a moron unless you really are right?

In other words, if the option...

Let's say we had stock options.

Let's say the option price was $30 a share and the market price was $20 a share.

Wait a sec, would you exercise that option?

No.

Why not?

Because you've going to give me more and get less, that's antidilutive.

You wouldn't exercise the option, you'd just go out in the open market and buy 'em for

20 bucks a share right?

We don't assume you're a moron unless you really do exercise it.

Assuming you don't, could you exercise?

Yeah.

Is it dilutive?

No.

Then don't include it.

Let's change the numbers, let's say the market price is 40.

If you convert, everyone gets $10 less right?

In this case because if you were to exercise this option, you would give me 30, I'd have

to give you 40, that means I have $10 less for everybody else, that dilutes how much

they get.

When we talk about these things that are convertible, we're only going to include them if they are

what?

If they are dilutive, which means earnings per share should start big and get less and

less and less.

If earnings per share would get bigger if you converted, then we don't.

Even though you could convert, it's not economically advantageous, we assume you're not, we don't

include it.

What I want to do is I come across, and do this calculation.

Let me clean this up just a little bit, I'm moving this over, okay.

We started out here we said, Net income minus preferred, boom, divided by weighted average

number of shares outstanding.

We defined weighted average says what, dividends and splits retroactive, go through and take

the partial year and so on.

Now we're going to take this number and bring it here, we're going to take this and bring

it to here and make some more adjustments.

We're going to adjust for number two, number three.

Number two, number three.

Okay, now what do two and three mean?

Number two is called the "If Converted" method.

Two, I'm going to put over here, two If Converted method.

Now what does the If Converted method mean?

What kind of things are convertible?

We could have what?

Convertible bonds, convertible preferred stock.

This is going to be for convertible bonds, and preferred stock.

What it says is if they converted, what happened?

If you converted the bond, what would I not have to pay you?

Interest expense.

If you converted the preferred, what would I not have to pay you?

Preferred dividends.

What would you convert into?

Common stock.

The If Converted method says, Okay, can you convert?

Yes.

Is it economically advantageous?

Meaning it's dilutive to everybody else?

Yes.

Then we go, Okay, let's assume you did it, we'll add the numbers in.

What this says is, If Converted method says, Okay if you converted, what would happen?

That's what we're going to go back and add back certain amounts.

If you converted here, what would I add back?

Well here's the dividends right?

If you converted, I wouldn't have to pay you the preferred dividends.

I'm going to add the preferred dividends in, now dividends come out of after-tax dollars

right?

Therefore it would be not net of tax.

Just add them back, or bond interest.

The bond interest would be the interest expense.

The bond interest expense, that would be added in net of tax.

Why?

Because if you converted, I wouldn't have to pay you bond interest.

That means I would have extra money but that money would get taxed so I would have that

net of tax to give away.

The preferred dividend came out of after tax, if you convert I go that extra 200 grand,

I could just give it away.

That one's not net of tax.

Under the If Converted method, what are we looking at?

We're looking at things like, convertible bonds, convertible preferred stock.

All right, so what it assumes, is the securities are converted at the beginning of the period,

or when issued if they are issued during the year.

Assume it's at the beginning of the year, or during the year if the securities were

issued during the year.

It also says, we're going to eliminate things like the interest, net of tax.

We're going to then add back the preferred dividends.

Those are things we're going to do, under this thing called the If Converted method.

For preferred dividends again what do we do?

We took them out here to get this.

If you could convert and they were convertible and it was advantageous, then we take that

and add back that preferred dividends and that net of tax.

What would you add in the bottom?

Well, they would tell us in the question how many shares the convertible preferred are

converted into plus the number of shares of common stock converted into.

We would add that back.

Plus the number of shares that common stock converted into.

That's going to be the number of shares converted into.

We're going to add that back because those are how many share?

Again I got more money, but I'm giving out more shares.

We're assuming the net, net is going to drop everyone's earnings per share, otherwise it's

not dilutive.