Diluted EPS (Earnings Per Share) | Formula | Use - YouTube

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clicking the bell ican friends today we're going to learn tutorial on diluted EPS as you

can see this is Colgate Palmolive diluted EPS and we have something over

here is that you know there's a difference between diluted and basic

EPS let's have a look at this we know that there are two variations of EPS one

is basic another one is diluted in Colgate why there are two types of EPS

that are reported here so let's understand first what is the diluted EPS

so the first and the foremost thing that you need to learn to calculate the

diluted EPS start from the basic EPS and then remove the adverse effect of all

the diluted securities or outstanding during the period so what you'll do you

will first need to identify all the potentially dilutive securities like

convertible bond options preferred stock warrants and so on and so forth second

you need to compute the basic EPS once you compute the basic EPS the effect of

the potentially diluted security is not inherent in the computation the third

you need to determine the effect of each potentially diluted security on EPS to

see whether it is diluted or anti diluted how compute the adjust a EPS

assuming the conversion occurs so if the adjusted EPS if it's adjusted an EPS if it

is greater than basic EPS then the security is relative fourth exclude all

the anti dilutive securities from the calculation of the dilute earning per

share fifth use basic use basic and dilutive securities to

calculate the diluted EPS first discuss in detail effect of the convertible debts

on the dilutive earning per share upon conversion the numerator that is the net

income that which is the numerator of the EPS basic EPS formula increases by

the amount of the interest expense net of taxes asserted with those increased

by the amount of interest expense net of tax associated with those potential

common shares Why if converted there would be no interest of the bond for the bond so

income available to the common shares will increase accordingly

and the after-tax interest is used because the ball interest is tax

deductible while the net income is computed on an

after-tax basis so what is the effect on the denominator upon conversion the

denominator that is the weighted average number of shares outstanding okay

it's called WASO of the basic EPS formula increases by the number of

shares created from the conversion and the weighted number the weighted by the

time the shares would be outstanding number of shares due to conversion is

equal to the par value of the convertible bond and convertible price so your

diluted formula will go something like this so this is your diluted EPS formula

the net income minus all the preferred dividend you add back any convertible

preferred dividend divided by the weighted average common shares

outstanding plus any shares from the conversion of the convertible preference

shares now the next step we are going to learn

is the diluted EPS calculation with an example

let's say during 2006 there's a company called KK Enterprise reported its net

income as $2,50,000 and it had one lakh shares of common stock so during

the 2006 the KK Enterprise issued 1000 shares of 10% par $100

preferred stock outstanding each convertible into 40 shares so what is

the net income $2,50,000 the preferred dividend is how much as you can see 1000

shares of 10% of 100 so 1000 into 100 into 10% that gives us 10,000 and what is

the common stock that is $1,00,000 which is as visible to us $1,00,000 shares so the

basic EPS going is going to be $2,50,000 plus 10,000 so you need to deduct

the preferred dividend that is $2,40,000 divided by 1,00,000 which will give you

2.40 now let's go to the diluted EPS the net income - 2,50,000 preferred dividend

10000 but the convertible preference shares is dilutive in nature so that is

10000 so it will stay the same deduct you add this $2,50,000 will remain the

same the common stock and the convertible preference share so 1000

into 40 convertible it's written each convertible into 40 per share so that

gives us an idea regarding that 40 shares have been converted so 1,000 into

40 gives us 40,000 so common stock is 1,00,000 and convertible preference shares

40,000 which gives us 1,40,000 shares so you need to divide the net

income to 2,50,000 divided by 1,40,000 that gives us 1.79

so we calculate the basic 2.40 and dilutive as 1.79 so is it a diluted or

anti diluted right so by this we can get to know that you know basic is more

than the diluted EPS now let's understand the effect of the convertible

preferred stock upon the conversion the numerator of the basic EPS that is a net

income of the basic we us would increase by the amount of the preferred dividend if

the converted there would have been no dividend for the convertible preferred

stock so income only available to the common shares will increase

accordingly and it is different from the ball interest preferred dividend and are

not tax deductible if we see on the denominator upon conversion the

denominator of the basic EPS formula would increase by the number of shares

created from the conversion weighted by the times that the shares would be

outstanding number of shares into conversion rate right so that with the

case now let's understand the diluted EPS calculation example having the

effect of the convertible preferred stock

so the next example that we are going to take is of options and warrants so

Treasury stock method is usually used to calculate the impact of diluted and you'd

have securities this method basically assumes that the options and the

warrants are exercised at the beginning of the year and proceeds from the

exercise the options are used to purchase the common stock so the three

step by which you can calculate is that first in the money options and warrants

are assumed to be exercised in the money means is a profit over there the process

the proceeds from the exercised are assumed to purchase the common stock at

the average market price during the period and the balance that is the

incremental shares number of shares issued minus the number of shares

assumed to be purchased will be included in the denominator of diluted EPS now

let's take the diluted EPS calculation example with the options and warrants

there's a company called KK enterprise again with net income $2,50,000 is same

1,00,000 common stock it issued 1,000 shares of 10% of 100 preferred stock

outstanding in addition the company has 10,000 options with strike price of two

and the current market price is 2.5 now let's calculate income

10,000 re deduct basic EPS everything remains the same denominator that is the

shares 1,00,000 basic shares plus 10,000 in the money option over here which was

quite visible to us in the addition the company has 1,000 options with strike

price of two so 1000 in the money option less the 8,000 that I'll

that have been bought back with the strike price of two and the current

micro market price of 2.5 so the buyback has to be deducted right it

is as simple as that so once we calculate this we have net

income you have preferred dividend common stock in the money options and

that you deduct the share repurchase you get the 2.35 as the diluted EPS of the

company so how useful is diluted EPS to the investor very simple thing first the

diluted EPS per share isn't very very popular among the investor because it is

based on what if analysis but it's it's quite popular

among the financial analysts that they want to ascertain an organization

earning per share at the trust since second the basic assumption behind

calculating the diluted EPS is that what if the firm other convertible

securities gets converted into equity shares the third thing is that the basic

assumption behind calculating the diluted EPS is that what if the firms

other convertible security gets converted into equity shares fourth

if the firms cap structure if the form capital structure is complex and

consists of stock options warrants debt etc along with out to outstanding equity

shares then the diluted earning per share must be calculated debts fifth the

financial analyst and potential investor who are very conservative in judging the

company's earning per share assume that all the convertible securities like

stock options Warrants debts etc can be converted into equity shares and then

the basic EPS would be reduce sixth you can see though this idea all the this

idea that all the convertible securities will convert into equity shares it's

just a fictitious one still calculating diluted EPS helped a potential investor

look at through all the aspects of the company's capital structure so that's it

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